格南登福 (IR) 2017 Q2 法說會逐字稿

Good morning, and welcome to the Gardner Denver Second Quarter 2017 Earnings Conference Call.

(Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Vik Kini.

Please go ahead.

Thank you, and welcome to the Gardner Denver 2017 Second Quarter Earnings Call.

I am Vik Kini, Gardner Denver's Investor Relations leader.

And with me today are Vicente Reynal, Chief Executive Officer; and Todd Herndon, Chief Financial Officer.

Our earnings release, which was issued yesterday, and a supplemental presentation which will be referenced during the call are both available on the Investor Relations section of our website, gardnerdenver.com.

In addition, a replay of this morning's conference call will be available later today.

The replay number as well as access code can be found on Page 2 of the presentation.

Before we get started, I would like to remind everyone that certain of the statements on this call are forward-looking in nature and are subject to the risks and uncertainties discussed in our previous SEC filings, which you should read in conjunction with the information provided on this call.

Our full disclosure regarding forward-looking statements is included on Page 3 of the presentation.

Turning to Page 4. On today's call, Vicente and Todd will review our second quarter highlights and financial performance as well as our segment results and 2017 guidance.

We will conclude today's call with a Q&A session.

(Operator Instructions)

At this time, I will now turn it over to Vicente Reynal, Chief Executive Officer.

Thanks, Vik, and good morning to everyone on the call.

We're excited to review Gardner Denver's second quarter results as well as to provide color on the current operating environment for our 3 segments.

Turning to Page 5. I would like to spend a few minutes on the second quarter highlights that marked our first quarter as a public company since our recent IPO, which occurred on May 12.

As you saw from our earnings release yesterday, Gardner Denver reported strong results with solid broad-based performance across all 3 of our segments.

Consolidated revenues for the second quarter were $579 million, up 25% versus prior year and up 27% excluding FX.

As a result of this strong revenue performance and the continued execution of our operational efficiency initiatives, we were able to deliver adjusted EBITDA performance of $132 million in the second quarter, representing a 53% improvement versus prior year.

This resulted in adjusted EBITDA margin of 22.8%, which was 410 basis points higher than the prior year.

Even more encouraging is that our margins continued to show positive momentum across all 3 of our segments, with Industrials, Energy and Medical each delivering year-over-year margin expansion well in excess of triple-digit basis points.

Our adjusted EBITDA margin was the highest second quarter margin ever in the history of the company.

Our performance in the second quarter reflects a good balance of both growth-based revenue and operational efficiency initiatives.

This balanced execution, coupled with an improving demand environment for many of our products and services, has increased our expectations for full year 2017 financial performance as compared to our view entering the year.

And as such, we're initiating full year 2017 adjusted EBITDA guidance in the range of $510 million to $530 million.

As our results and performance indicate, we feel that we are continuing to build a premier industrial company with attractive growth levers over the near and long term.

Turning to Page 6. I would like to spend a few minutes discussing our simple and straightforward strategy.

When I joined Gardner Denver in 2015, the company was comprised of a fantastic array of businesses, powerful brands and over 150 years of history.

However, it was missing a unified strategy to unlock its full potential.

To address this, we developed a straightforward strategy based on 4 simple principles: first, building and deploying talent; second, expanding margins; third, accelerating growth; and fourth, efficiently allocating capital.

Let me start with deploying talent.

Our employees are at the center of everything we do, and I'm a firm believer that the best team wins.

Over the past few years, we did a good job of infusing the business with unique domain expertise and functional leadership.

The result is a strong blend of new talent and leaders with deep institutional knowledge and passion to succeed, a combination that will lead the business to its next stage of growth and profitability.

We are now focused on harnessing the power of over 6,000 highly engaged employees, who think and act like owners.

During our IPO, we granted over $100 million in equity to all of our employees.

This provides them with a tangible financial reward of ownership and motivates them to identify and drive actions at their local level, actions that are aligned with our common strategies.

These, in turn, will contribute to stronger revenue growth, profitability and cash performance for the company.

During the second quarter, we also launched an employee engagement initiative targeted to ensure that Gardner Denver is a great place to work.

This multi-year initiative will involve surveying our employees globally, to identify what works well and what doesn't, training our employees on certain targeted aspects of value creation for the company and ensuring our employees have the right tools, development and recognition to be successful in their roles.

This is a large commitment from both the company and our employee base to create a highly engaged workforce.

The second aspect of our strategy is expanding margins.

We believe that a willingness to appropriately invest in the business accelerates margin expansion.

And clearly, our investments, whether it is reconfiguring factories to create mixed model, single piece production lines or adding engineering personnel to facilitate VAVE were key factors in us achieving 410 basis points of adjusted EBITDA margin expansion in the second quarter.

While we're pleased with the results, we're still in the early innings of our transformation.

The third leg of our strategy is accelerating growth.

And over the past 24 months, we streamlined our innovation and product development cycle by introducing a global product management and technology organization across each of our businesses.

The result has been a dramatic improvement in the pace of innovation.

For example, in the Industrial segment, we've recently introduced the Ultima oil-free compressor, which was developed from concept to launch in less than 12 months compared to a historical development timeframe of 24 to 36 months.

We also improved our sales processes by linking our commercial and product management efforts to a dedicated externally focused demand generation team.

And the results here have been quite impressive, delivering a 60% increase in the number of leads per week.

The final leg of our strategy is the efficient allocation of capital.

Our current focus balances the internal needs of the company with strategic M&A and leverage reduction.

This quarter, we continued to fund innovation and profitability improvement initiatives and also added a strategic asset with the acquisition of LeROI Compressors, which we were able to fund from available cash.

LeROI is a strategic bolt-on acquisition that fits our transaction criteria of mission-critical technology with high cost of failure, strong aftermarket profile and solid commercial synergies.

LeROI is also a great example of deploying our strong cash generation and adding a strategic asset to our portfolio in this highly fragmented market.

Our M&A funnel continues to be robust, and we will prudently evaluate opportunities as they come available.

In conclusion, we're executing our simple, our straightforward strategy every single day.

We have an extraordinary team that is passionate about the creation of a performance-driven culture that delivers results.

I will now turn the call over to Todd to take us through the second quarter financials in more detail.

Thanks, Vicente, and good morning to everyone.

If you turn to Page 7, I will review the financial performance of the total company.

As Vicente indicated earlier, total Gardner Denver Q2 as reported revenues were $579 million, up 25% compared to 2016 and up 27% when excluding FX.

This now brings first half revenue to $1.1 billion, which is an 18% improvement over prior year on an as-reported basis and up 20% when excluding FX.

Our Q2 performance clearly reflects the improving demand environment and commercial execution we are seeing across our businesses as all 3 segments saw sequential increases in revenues from Q1 to Q2.

In addition, order levels across the portfolio continued to remain healthy with order intake in Q2 of $605 million, resulting in an aggregate book-to-bill ratio for the company of 1.13 over the first half of the year.

As a result, we have a healthy backlog entering the second half of the year, which is historically seasonally stronger for industrials and energy.

Our Q2 adjusted EBITDA was $132 million, up 53% compared to the same period in 2016.

For the first half of '17, our adjusted EBITDA stands at $224 million or a 37% increase over the first half of 2016.

Q2 marks the third consecutive quarter where we have seen adjusted EBITDA levels increase on a year-over-year basis.

And more impressive is that our adjusted EBITDA margins continued to show positive momentum across all 3 of our segments.

In the second quarter, our adjusted EBITDA as a percentage of revenues was 22.8%, which was 410 basis points higher than the second quarter of last year.

In addition, we saw 370 basis points of a sequential margin improvement exiting Q1.

Even more impressive is that the improvements are not just driven by 1 segment, but again, instead, all 3 of our segments saw significant margin improvement.

Industrials continues to show progress as adjusted EBITDA margins improved 300 basis points versus prior year.

Energy saw 620 basis points expansion, and Medical saw a 300 basis points improvement on relatively flat revenues.

We are extremely pleased with these results as they show the teams' commitment to our strategy of balancing top line growth and operational improvements.

On a GAAP basis, we reported a second quarter net loss of $146.3 million or a loss of $0.83 per share on a share count of 176.9 million.

The second quarter GAAP net loss included $226.7 million of pretax expenses for stock-based compensation, loss on early extinguishment of debt and other fees related to the IPO.

We delivered adjusted net income of $43.7 million and adjusted earnings per share of $0.24 on 182.2 million average shares.

This marks a 41% improvement over the prior year of $0.17 per share on 152.8 million shares.

A full reconciliation of our second quarter and year-to-date GAAP net loss and loss per share to adjusted net income and adjusted earnings per share is included in our earnings release as well as in the appendix of the slide deck.

Moving to Page 8. I would like to spend a few minutes discussing our cash performance and the trends we are seeing.

Starting first with working capital, we saw the Q2 level of 2017 working capital as a percentage of LTM revenues decrease 220 basis points to 30.4% as compared to 32.6% in the prior year.

While we are pleased with the improvement, we fully recognize that working capital as a percent of LTM revenues in excess of 30% leaves us runway for improvement in future cash generation.

One of the major initiatives we are deploying across the organization, linked to our employee engagement activities, is a working capital improvement program.

I've recently trained 150 people in the organization on working capital and working capital improvement, and those 150 people will be training all of our employees in the next several weeks.

We are already starting to see some quick wins coming from employees across the organization, and we are confident that when we start sharing best practices across our enterprise, we will see improved working capital performance.

Our reported free cash flow for the second quarter was $12 million and was negatively impacted by a number of transactions related to our IPO, including accelerated interest payments of $10 million in connection with the retirement of our senior notes as well as a onetime $16 million sponsor monitoring agreement termination fee.

Excluding these 2 items, we delivered $39 million of free cash flow, which was up 69% year-over-year.

Finally, I would like to address our capital allocation strategy.

In May of this year, we completed a primarily offering of 47.5 million shares of common stock that yielded $852 million of net proceeds, 100% of which was used for debt repayment.

As a result, our leverage was 3.8x at the end of Q2, which represents an improvement of 3.5 turns versus prior year and 0.4 turns versus Q1 on a pro forma basis applying the net IPO proceeds.

We feel that the momentum we are seeing, coupled with the expected improvements in both adjusted EBITDA and cash performance in the second half of the year, will put us well on our way to achieving our stated leverage goal of less than 3x.

Overall, we ended the second quarter with $246 million of cash and $634 million of available liquidity.

In addition, we recently increased our borrowing base under our receivables financing agreement by $50 million to give us incremental liquidity.

We continue to remain comfortable with our overall liquidity position, and we feel that it affords us the flexibility to balance future investments, M&A and further debt pay-down.

I'll now turn the call back over to Vicente to provide more color on our segment performance.

Vicente?

Thank you, Todd.

Moving to Page 10, I'll start with the Industrial segment, where Q2 performance continued a positive trajectory we have seen over the past few quarters, with an improving demand environment, coupled with strong flow-through due to operational improvement.

This now marks the sixth consecutive quarter of solid year-over-year margin improvement.

The Industrial segment second quarter order intake was solid at $281 million or up 6% excluding FX.

Revenues in the quarter were $283 million, up 2% excluding FX.

In addition, Q2 revenues were up 14% sequentially versus Q1.

We are executing our growth strategy with particular strength in the Americas and Europe.

In the Americas, we saw solid double-digit orders and revenue increase in the first half of the year across the entire suite of products, including compressors, vacuums and blowers.

In our European region, we are also seeing solid performance as the demand for core products and, most notably, vacuum and blowers are leading the way as well as success in many niche areas, like custom packages for use in the emerging markets like the Middle East.

In Asia, which is our smallest region in terms of revenue, the results have been a bit more mixed, particularly in China.

This is an area where we've recently launched our new localized compressor technology developed in the region for the region, and we are aiming to gain share in this critical market.

We are also very pleased with the progress we are seeing on innovation.

The Robox blower, which you can see on the bottom right of the page, is a testament to our new product innovation process that is focused on addressing the voice of the customer.

Nearly 60% of the energy cost in a wastewater treatment plant are from blowers used in water aeration, and the wastewater industry was demanding a solution.

To answer this challenge, we developed the Robox Energy Screw Blower, which reduces energy consumption by up to 50% and also incorporates a remote connectivity platform, iConn.

As you would expect, this product is seeing a very nice traction in the market, and it was recently awarded the 2017 Motion Control Industry Award in the category of environmental and energy efficiency.

This is a great win for the organization, and I congratulate the entire team on their efforts.

Moving to adjusted EBITDA.

Industrial delivered $63.4 million, up 18% excluding FX.

As a percentage of revenues, second quarter adjusted EBITDA was 22.4%, 300 basis points better than the same period in 2016.

For the first half of the year, this now brings adjusted EBITDA to $111 million and margins of 20.8%, which reflect 13% ex FX growth and 210 basis point improvement, respectively, versus prior year.

The Industrial segment continues to see profitability improvements on a year-over-year basis, with very impressive adjusted EBITDA flow-through of 425% in the quarter.

Moving now next to the Energy on Page 11.

As the numbers show, our performance in Energy continues to be quite strong as we are benefiting from improved performance in upstream energy due to the activity levels in the onshore North America oil and gas market as well as solid execution in the mid and downstream.

The Energy segment second quarter order intake was very robust at $266 million, or up 110% excluding FX.

Revenues in the quarter were $239 million, up 95% excluding FX.

In addition, Q2 revenues were up 34% sequentially versus Q1, with improvements across up, mid and downstream.

Our aftermarket performance, which is core to our strategy, continues to be very strong as well, up 135% year-over-year and now comprises 56% of our LTM revenues, which is approximately 900 basis points improvement from the end of 2016.

Activity levels in upstream energy continue to be extremely strong.

Order intake in upstream energy increased over 600% versus the prior year, building on Q1, which was up in excess of 400%.

It is worth noting that the Q2 2017 order intake did not slow down versus Q1 2017 and, in fact, sequentially increased.

Revenue performance followed a very similar trend as upstream revenues increased by over 375% in the quarter, building on Q1 2017, where the increases were in excess of 200%.

The first half book-to-bill of 1.3 provides us with a very solid backlog entering the second half of the year.

Let me take a few moments to describe what we are seeing in upstream energy and how that translates to our performance.

Despite some volatility in oil prices throughout the quarter, fracking activity levels and intensity continued to increase, which is a very positive sign for equipment providers like Gardner Denver.

Currently, the market is seeing the average length of laterals in horizontal wells in excess of 7,000 feet as compared to approximately 5,000 feet only a few years ago.

In addition, due to improvements in efficiency, the number of wells drilled per rig continues to increase.

And given the longer laterals of these wells, there are more stages per well and more proppant being pushed to facilitate fracking.

And in fact, recent reports are showing that the pounds of proppant pumped per well in 2017 will be nearly 2x the levels we saw back in 2014.

This equation becomes extremely positive when taken in combination, as longer laterals drive more stages per well requiring higher proppant use.

This generates higher demand for our products and results in a stronger aftermarket.

As we look to the second half of the year, we expect the market to remain healthy with the demand for aftermarket products continuing to lead the way.

In addition, the replacement cycle for installed horsepower may begin to materialize, and it is widely believed that much of the installed base is at the end of its useful life.

We're excited by that prospect as our innovation efforts on the original equipment side have been high here.

At the bottom right, you will see our recently introduced state-of-the-art Thunder Pump, which has a longer life and improved performance, both key differentiators given the market's push for improvements in total cost of ownership.

We're also excited to report that in Q2, we actually shipped double-digit units of our Thunder Pumps for use in and outside of the U.S. And in fact, the picture you see on the right is for a customer in Kuwait.

We also saw a solid mid and downstream performance, with revenues up mid-single digits in the quarter.

These markets, particularly downstream, which is the larger of the 2, are benefiting from positive global trends not only in petrochemical and power generation end markets but also regulatory-driven applications like flare gas recovery.

In addition, in downstream, given our newly integrated production and service capabilities in the U.S., Brazil, Europe, India and China, we are seeing great traction in localizing production for customers, which dramatically reduces lead time to the customer.

Given the strong revenue performance across the entire Energy portfolio and the continued benefits we are seeing as we leverage many of the investments that we made during the 2015 and 2016 timeframe, the Energy segment delivered adjusted EBITDA of $62.2 million, up 156% excluding FX.

As a percentage of revenues, second quarter adjusted EBITDA was 26%, up 620 basis points.

For the first half of the year, this now brings adjusted EBITDA to $101 million and margins to 24.1%, up 111% excluding FX and up 470 basis points versus prior year.

Moving next to Page 12 and our Medical segment.

The Medical segment order intake and revenues were both $57 million, and both were effectively flat excluding FX versus the prior year.

The flat performance is largely in line with our expectations and driven by a significant gas pump customer that is transitioning to a dual-source approach.

The result is a phased step-down in revenues on a yearly basis, which we will be seeing evident in the Medical revenue profile in 2017 and, to a lesser degree, in 2018.

We're encouraged by the progress we're seeing in our strategic growth initiatives of Liquid Pumps & Liquid Handling to become a differentiated solutions provider of products for use in highly regulated industries such as food, pharma and life sciences.

In addition, the efforts of the team to launch new innovation in our core gas pump market continues to yield positive results.

A great example is shown on the page in the form of the CRVpro rotary vane vacuum pump.

This pump is sold under our Welch brand and is used largely in lab and life sciences applications, where specific temperature requirements, chemical resistance and increased reliability are critical.

This product has been a nice win for the team as we are currently seeing a strong momentum, with order rates up double digits year-over-year.

And despite [bigger] top line growth, we saw strong adjusted EBITDA performance of $15.4 million, up 12% excluding FX.

As a percentage of revenue, second quarter adjusted EBITDA was 27.1%, up 300 basis points.

For the first half of the year, this now brings adjusted EBITDA to $30 million and margins to 26.8%, which were up 9% excluding FX and up 190 basis points, respectively.

The Medical team has shown strong ability to implement and operationalize profitability-improvement initiatives, such as VAVE and restructuring, which have complemented our strategic entry into the higher-margin Liquid Pumps & Liquid Handling solutions niche.

With that, let me turn it back to Todd to provide 2017 guidance.

Thanks, Vicente.

Slide 14 provide some key highlights for our 2017 guidance.

First, we're introducing adjusted EBITDA guidance of $510 million to $530 million.

Our outlook has improved from the beginning of the year, largely due to our strong first half performance, our confidence in our ability to execute our strategy and the improving demand environment, aided by slight FX tailwinds, particularly the euro, in the second half versus the first half.

We do expect the typical seasonality that is inherent in our business to be reasonably consistent with prior years, namely: Industrials typically experiences a slightly stronger second half with the fourth quarter being the strongest; within the Energy segment, upstream will follow the market trends outlined earlier, midstream and downstream Energy revenues tend to be stronger in the second half, primarily due to longer cycle projects.

However, in 2016, particularly in downstream, the majority of our longer cycle shipments occurred in Q4 versus Q3 due to customer delivery requirements.

The result was an abnormally weaker 2016 Q3 and a stronger 2016 Q4.

We expect a more balanced second half in 2017, subject to customer delivery requirements; finally, Medical has minimal seasonality.

We would expect our capital expenditures to be in the range of $65 million to $70 million.

We also expect year-end leverage to be in the range of 3.0x to 3.3x, driven by stronger second half cash flow and continued adjusted EBITDA performance.

Finally, we are providing guidance on our share count, which is complex due to the mid-year impact of the IPO.

Our average diluted shares outstanding for the total year are forecasted at 187.9 million shares, using share count and share price as of June 30 for the second half of the year.

And now back to Vicente to wrap things up.

Thank you, Todd.

Moving to Page 15.

We're very pleased with our second quarter performance and our continued momentum.

As we enter the second half of 2017, we will remain very disciplined in executing our simple and straightforward strategy that we expect will generate significant ongoing value creation for our shareholders.

With that, we will turn the call back over to the operator and open it for Q&A.

(Operator Instructions) And the first question comes from Andrew Kaplowitz with Citi.

So Todd, I appreciate the color on the guidance, just maybe a little bit more.

When we look at your new EBITDA guidance, can you give us a little more color on the pieces?

And what I mean is we do expect sequential improvement in Energy.

I'm sure -- you did 30%-plus incrementals last quarter.

But how much improvement could come from your Industrial business?

We did see a bit of a step-up in Industrial revenue on a more difficult comparison in Q2.

So can we think about low and even mid-single-digit revenue growth following your order growth in the second half of 2017?

We don't give specific segment guidance, but you can tell from the order intake and book-to-bill ratios that we saw in the first half that we have a pretty good backlog coming into the second half.

And I think we've traditionally said that we'd like to grow this business at GD-plus kinds of rates.

So I'd take that input as some significant input to the back half.

We are reasonably confident in our year and where it's headed.

Also, just for the -- sorry, one follow-up, too, for those on the phone.

We didn't announce it, but our 10-Q will get released tomorrow morning.

Okay.

And then, Vicente, you gave good color on the Energy business.

But can you talk about the duration of the Energy order visibility that you have?

If we assume that U.S. rig count is flattening out from here, how do we think about your Energy growth as we transition into '18?

Does the estimate of revenue up 135% and more than half of Energy revenue give you confidence that there still should be the transition to OE that you talked about in '18?

And could you record good Energy growth even if rig count is flat?

Yes Andy.

Thanks.

So the way I look at it is, obviously, the Energy segment has kind of the 2 pieces of -- or 2 main components.

We have the upstream side and then it has the mid and down.

The mid and down, as you heard from the remarks, continues to do very well, growing healthy.

If you remember back in the '15 -- or the '14 to '16 downturn is -- it also grew high single digits.

So we continue to see some good momentum on that side of the business, and we expect that to happen also here on the second half.

On the upstream side, I've said many times that the rig count is an indicator that many people look at, and obviously, we pay attention to it.

What we like to really look into is more the intensity of the wells.

Because keep in mind that a lot of the pumps are really working harder now out in the field.

There's some statistics now that say that back in 2014, a typical pump was running about 1,800 hours per year, whereas now, they're running 2,500 hours per year.

So that kind of tells you that the pumps are working harder.

At the same time, the longer laterals are almost 2x, and the proppants that you're pushing through the wells are twice the volume of what it was back in the last peak.

And we have seen that to continuously increase.

And same with the number of stages, I mean, stages going from, call it, roughly 280,000 stages in '15 to now 500,000 stages as of 2017.

So I think the way I like to think about it, Andy, is that even if the rig count continues to be flat, the level of intensity seems to continue to increase as we see stages and intensity increase due to longer laterals.

And the next question comes from Mike Halloran with Baird.

So let's start on the Energy side.

Obviously, some nice color you gave on the original equipment cadence versus the aftermarket cadence.

Maybe deep dive into that a little bit more.

Aftermarket is still strong here.

What do you think it takes from a sustainability of the trend to start seeing that original equipment back?

Is it simply just time?

Because the installed base is starting to get old, when would you envision that starting to turnover, become a little stronger?

And just a little bit more color on that side of things.

Yes, Mike.

I think, definitely, a little bit of more time.

I think those statistics that I just mentioned in terms of the intensity, obviously, from a frac point perspective, you can see that some statistics say, that 65% of the available horsepower in the market is beyond the useful life.

And not only that, but they're working harder.

I mean, you heard what I said about the number of hours per year per pump, that they're getting worked up now.

So the way we like to think about it is that wave of new pumps -- new frac pumps may come in '18.

I think right now for '17, we're not counting.

I mean, obviously, we're ready for it if it comes.

You also saw that we are starting to see a little bit of influx and particularly based on our new pump, our new innovation with the Thunder Pump, that is doing extremely well out there based on any new additions that we're seeing in the market.

So...

In your view, if the environment is stable in the next year, those original equipment pumps would have to come back even on flattish overall activity levels?

That's exactly the way we think about it, yes.

Okay.

And then one on the Industrial side, 10% orders, first quarter; 6% orders, second quarter.

Could you just help understand how that translates in terms of what the lag is on that side?

And was there anything interesting in terms of cadence through the quarter in terms of activity level?

Yes, Mike.

So if you look at the first half order rates, obviously, up 8%, approximately.

So I mean, clearly good momentum; book-to-bill 1.07.

So that puts us very nicely into the second half and see a kind of good momentum in terms of growth rates as we see second half versus the first half.

In terms of kind of sequential momentum within the second quarter, we actually saw some very good acceleration in Europe.

So our European business is doing fairly well.

And we saw a very good momentum exiting the second quarter.

And as we said on the remarks, I mean, the Americas team continues to do just extremely well from an order and revenue perspective throughout the first half.

And the next question comes from Joe Ritchie from Goldman Sachs.

My first question, maybe just sticking with Industrial for a second, clearly, really good quarter from a margin perspective.

I guess, how much of the margin improvement was driven by the restructuring benefits coming through?

And maybe, can you talk about your expectation for 3Q, 4Q just for restructuring specifically?

This is Todd, I'll take that one.

We, as you know, had an ongoing restructuring program, and clearly, there is some benefit in '17 from the flow-through actions from '16.

But I would say the margin benefit, it comes from a number of combinations of things.

Some of it being the VAVE projects you've heard Vicente talk about, some of it being the Lean initiatives that we've implemented and are in the middle of implementing, and then also additions just because of the overall headcount restructuring that is evident in the business.

As we look forward and outlook in the remainder of the year, we'd expect, again, strong margin improvement consistent with what we've been talking to the market about in terms of continuing multiple lines that impact our margins in a sustainable way.

And so we're comfortable with the exit rate out of Q2 and incremental volume related to -- our book-to-bill is going to help us as well in the back half.

Okay, got it.

And maybe, Vicente, along those lines, you mentioned kind of being in the early innings of your transformation.

Maybe some initial thoughts on carrying the momentum beyond 2017 and 2018, what else can you do specifically around restructuring to take costs out of the business as it stands today, given the fact that your margins are already really good across a lot of the different businesses within your portfolio?

Yes, Joe.

So we -- we're -- we definitely still feel we're in the early innings.

And when you think about it, it's not only just restructuring but really, the implementation of Lean manufacturing across our factories.

And really the focus as well on VAVE.

Keep in mind that 70% of our cost of goods sold really comes from direct materials.

So we're doing a lot of really great work to improve our gross margin.

And when we see the gross margin expansion in Industrials, it's keeping us very comfortable that we'll see some good momentum continue into that.

Also, as we are turning our stage now into having our Industrial segment to grow, obviously, with the way we have structured the organization, and as I've mentioned before, how we have simplified and delayered the organization, we definitely feel that we'll continue to see some good flow-through on operational leverage based on the restructuring that we have done over the past few years.

So it's not that it requires more restructuring, but it's really now leveraging what we have done and continue accelerating the gross margin improvement efforts in industrials.

And the next question comes from Damian Karas of UBS.

So it was nice to see the mid and downstream orders also growing along with the really strong upstream performance this past quarter.

I was wondering if you could maybe just talk a little bit about the NASH business in particular and what you're seeing there in terms of the downstream project pipeline.

Yes.

Damian, something that's very exciting for us, and we spoke a little bit about this during the roadshow, is that what we have created now in the downstream is a very unique platform, where we have liquid ring vacuums and liquid ring compressors all within one same umbrella, and that's with the NASH and the GARO business, which are 2 leading brands.

And as I mentioned in the remarks, what we have been working here over the past, I'll say, 9 to 12 months and the team, the NASH and GARO team, has done a really great job is really leveraging the global factories that we have within that business to now be able to be very nimble in supporting the customer requirements.

So we're now leveraging our engineering technology landscape and our engineering team to really go after all projects that we see we can generate some very solid margin.

Just even this past -- actually, this week, the team was announcing a very good order that we're able to obtain in India for some shipments in Saudi Arabia.

So it just tells you about the globalization of that platform and how we have been able to leverage our entire team and not only the team but also from a technology perspective.

Okay.

And on working capital management, it looks like you're making some really nice progress there.

And Todd, you talked a little bit about the runway for further improvement.

But could you maybe take that a step further in terms of the potential opportunity?

How much improvement are we potentially talking here?

And how long do you think the initiatives you're taking are going to potentially take to play out?

Yes, let me just talk for a couple of minutes about our process.

Because we've implemented a new process as a company and reporting over the last 6 to 12 months.

So we're now also leveraging an entire program into the total company, where in the last week or 2, I've trained 150 people personally that are now going to cascade a networking capital program that relates to our engagement that Vicente mentioned as well, in terms of getting all of our employees rallying around a specific program that they can feel accountable for and have a direct influence on.

And even this week, we heard a response from an HR person in South Africa that has, on her own, renegotiated the terms, for example, of a -- with a vendor.

And that's a good example, that's just really operational, of something that came out this week that you wouldn't typically expect to see.

And so there's a big focus within the company on working capital.

In terms of targets, we clearly are targeting less than 30%.

We know there's room for improvement, and we're excited and think we'll see some good benefits as we come into the second half here, both in the areas of inventory, in particular.

We've also standardized a lot of processes now in our shared service center around payments and have monthly meetings now measuring cycle times and very specific deliverables.

So we like where we're headed, and we think we'll see some significant improvement.

And the midterm targets in north of the mid-20s, we've got our eyes on.

So that's our view.

And the next question comes from Bill Herbert with Simmons & Company.

Vicente, if we could just delve a little bit more deeply with regard to the order outlook for upstream Energy, if you kind of canvas the second quarter conference calls from some of your competitors, the refrain is that cap equipment orders, the discussions are ongoing and are healthy, but the sense of urgency compressed due to the weakness in oil prices late in the second quarter.

And so the discussions are ongoing.

It's just that the actual prosecution of the orders have been pushed out.

And then with regard to aftermarket, it's still very strong.

But on a sequential basis, the rate of growth is expected to flatten out in the second half of the year.

So I'm just curious what your reaction is to, effectively, that summary of second quarter calls from some of your competitors and what you're hearing from your customers.

Yes, Bill.

So obviously, we -- we're staying incredibly close to our customers.

During the downturn, we doubled our sales team, and we did that with the reason of being more focused our -- on the accounts.

And what we're hearing is that there's definitely not a slowdown from an activity-based perspective.

And as I mentioned before, we're not counting on kind of new equipment to come in here in the second half ourselves.

And obviously, we heard that from whether Halliburton or some of the other kind of larger players that are not adding, so to speak, fleets.

But what we do hear is that, definitely, the utilization of the current fleets out in the market are really getting worked up very aggressively, which, obviously, help us from an aftermarket perspective.

I think the other way -- the other thing I -- the other kind of dimension that I'd like to look at is, as you recall, we talked about the investments we made in the aftermarket.

We currently have more service footprint than what we had before, with many of them really just to open in the 2016 time frame.

But at the same time, the number of components and kind of, what we call, the value that we can provide to a pump from an aftermarket perspective has really increased by 50% compared to what we did back in 2014 based on the investments that we have done in valves, seats, plungers, packing, I mean, a lot of the consumables that we didn't have before.

So I -- so anyway, that's kind of the way we like to think about it.

Okay, that's super helpful.

And then secondly, if one were to submit an order today for a new frac spread, what would be the lead time to deliver that spread?

How many months?

So right now, we were -- from a new pump perspective, we could go anywhere between 2 -- it could be up to a couple of months.

So let's say 8 to 10 weeks, obviously, depending on how we can accelerate or not.

But it depends on also the customer on how -- I mentioned -- it's always been a little bit tricky, but I'd mentioned that we're spending a lot of time with our customers, and we're spending time with our customers to really understand what are the needs that they have.

And we're tying and matching our supply chain based on that customer requirement.

So we are keeping cores, we're keeping spares, we're also buying from a supply-chain perspective, based on what we see from a demand of what they may want to ramp up out here soon.

So we're doing things very different from what we did in the past from a standpoint of being very in tune with our customer.

I think our team has done a tremendous job getting very close to our customer.

And if it's a customer that comes in brand-new, sparkling, that wants to get a pump, obviously, we'll definitely do whatever it takes to service that pump or provide a new pump to them, and it could be anywhere between 8 to 12 weeks.

And the next question comes from John Inch with Deutsche Bank.

So this upstream strength, how much of this is coming from Permian?

And the kind of the crawler is that you guys relatively sort of put in place resources to participate in that critical basin.

I mean, just how much of this is sort of market versus Permian and kind of your own catch-up and proportionate share gain there?

Yes, John.

The way I'd like to think about it is that when you look at the overall upstream side, you can categorize that half of the growth is really coming perhaps maybe from kind of a market perspective or a little bit less than that.

And really, the majority of the growth that we see is from, what we believe, is the share take that either we're taking share or the new investments in, like, the Permian Basin facility as well as the other consumable products that we have that we didn't have before.

Yes, the reason I ask is you just hear a lot of talk about the Permian is really driving so much of the frac activity.

And not being an energy analyst, I'm just wondering if that's kind of consistent with what you're experiencing as well.

So I appreciate your share gain commentary.

But overall, the big picture is like Permian kind of 80% of what's going on with respect to the incremental upstream activity both from your perspective and market?

Or is it kind of less than that?

How would you think about it?

No.

Yes, so back at -- one of the things we like to think about it too as well is that roughly 65% of the kind of growth momentum is coming from 4 basins.

Two of them are oil basins, that will be the Permian and the Anadarko basin.

And then 2 of the other basins are really also from gas, because let's keep in mind that gas also -- there's a lot of fracking for gas, and that comes from the Barnett and the Marcellus basins.

And out of the 4, those kind of key basins that I mentioned, they're roughly 60% of the growth that comes in.

You can think about that maybe 30% of that or 1/3 will come from the Permian Basin.

So the Permian Basin is definitely a very permanent and where a lot of the investments is happening.

But we're also seeing some good momentum across other basins.

And the 4 basins that I mentioned, this is -- I mean, the growth is really coming because these basins, the breakeven points are fairly low.

I mean, oil could be low to mid-30s, and gas could be $2 and change.

So the other question I had was then on pricing.

I don't know if I caught this in your presentation.

But did price in terms of year-over-year price changes have any material impact on the margin performance?

And given industry capacity seems to be pretty tight, I think you guys have talked about this even in the analyst meetings and so forth, what are you doing with respect to pricing to kind of capture, obviously, a very strong cycle dynamic currently?

Yes, we're definitely -- spoke about that we are getting price.

We're building momentum, and we're looking at price -- increasing prices, actually, on a monthly basis.

But because we're still building the momentum, you could argue that still the improvement really from the price increases will really come more stronger on the second half.

But we are definitely taking price and taking advantage.

And as I've mentioned before, it is mainly because we're able to provide products in a much shorter lead time than competitors or, really, it's all about part of that Lean effort, Lean manufacturing effort, of being able to provide what the customer wants when the customer wants it.

And we have done -- and the team has done a really fantastic job on maintaining lead times low and be able to provide a premium price when the customer wants something faster.

Is there any way to quantify the impact of price, though?

No, we don't disclose the impact of price on a forward basis.

But what we can also tell you, related to Vicente's comments, are we, as you know, had some elevated CapEx investment during the private ownership time, and that is paying significant dividends for us right now in support of both more efficient manufacturing conversion costs as well as our ability to service those customers faster.

And we think that, that will continue in the back half.

Okay, well, let me ask it this way.

I mean, you hear about -- in the multi industry, you hear about product pricing.

If you can get pricing, pricing is a big theme to this quarter.

Maybe going up 1%, you had fuel costs rising and so forth.

This is an industry, it's kind of like monoline industry that's had a massive turn of demand, right?

You're up 90%, 100%, whatever.

Does price, in the industry -- does it go up 1%?

Or can it go up like 5%?

I'm just trying to gauge order of magnitude.

Okay, got it.

John, it will definitely go double digit.

I mean, we're looking double digit, yes.

Okay, that's exactly -- right, that's exactly what I was sort of hitting for.

And it also varies by the type of product.

So fluid ends could be double digit whereas maybe valves and switch could be single digits.

So there's also a little bit -- it's not a [peanut butter] across of double digit across everything.

It's based on where we see we can maximize, obviously, the price performance based on what the customer really wants at that time and how we can maximize our price.

So we're getting pretty sophisticated on the price and really being able to maximize it where we can.

Yes, that should be a pretty big margin driver, I would think.

Good stuff, appreciate it.

And the next question comes from Julian Mitchell with Crédit Suisse.

I had covered you in your previous incarnation, so it's good to have you back in public markets again.

If we think, firstly, I guess, around the sort of trying to wrap up the various strands of commentary on the Energy division.

So if we think about, let's say, the fourth quarter, very tough comps, but you've got very good order growth today.

Should we assume that you can still exit this year with a reasonably good positive growth rate in terms of year-on-year revenues in your Energy division?

Or it's too early to say?

No, I will say that it's still -- that we'll definitely have a positive momentum in the fourth quarter -- not in the triple digit because, I mean, keep in mind, we had a really strong fourth quarter in 2016.

Primarily driven by the long cycle business mid- and downstream.

And also, as you remember, the upstream was really troughing and kind of starting to grow back in Q4 of '16, so we're -- it's some tough comps, but we still should be in positive territory for sure.

Understood.

And then if we think about the, obviously, there's a lot of adjustments to the earnings numbers and so on given you're just coming out of the gate.

If we think about the cash flow, you talked about leverage shrinking over the second half, but if we look at, say, free cash flow conversion or free cash flow margin in the second half of this year and beyond, what sort of ratio should we expect if we're using, I guess, adjusted net income as the basis when you're looking at your cash flow?

First, I'd say, for sure, you're going to have acceleration versus H1.

And I think if you look at our guidance, we don't give specific guidance on that.

But I think we've given out the guidance on EBITDA, CapEx and cash taxes around $65 million, I would tell you, so -- and you know our cash interest.

So you'll see significant operating cash flow generation in the second half because we also have indicated that our restructuring programs are coming to an end and winding down.

And so at -- all of those things are going to lend themselves to some significant operating cash flow, which is why we've given some guidance on where we see our debt leverage going by year-end here.

I think we said between 3.0x and 3.3x.

So we're reasonably comfortable of the second-half cash flow generation.

And the other thing that I would just highlight again is that we do see some benefit from our working capital program in the back half that we think is getting some traction.

And then medium-term cash conversion is what, 100%-plus or so?

We're targeting best-in-class kind of industrials conversion, which would be around that.

And the next question comes from Nathan Jones with Stifel.

I wonder if we could go back to Page 6 of that slide show and walk through some of the strategy pieces here.

Maybe, Vicente, if we go back to when you got there, can you talk about what the major deficiencies you saw in the company in terms of Lean, in terms of sourcing, in terms of VAVE?

What progress you've made over the last 2, 3 years?

And what the opportunities are ahead over the next, I don't know, 3 to 5 years?

Yes, Nathan, definitely.

I think as I've mentioned during some of the times -- during the roadshow, I mean, kind of what I saw -- or well, I mean, what you have seen so far is, beginning with the talent, I mean, clearly, we have infused tremendous amount of talent.

45 of the top 100 leaders are new in the organization since 2014.

And as I stated, many of them coming in with very unique domain expertise.

Domain expertise around demand generation, could also be domain expertise around Lean manufacturing, so I've been very focused on hand picking and hand selecting the individuals that will definitely drive the next 3 key strategic imperatives that we have around expanding margins.

What I saw from a Lean manufacturing perspective is, what I may call, the early beginnings of Lean, perhaps.

What we have been very focused on, and Todd alluded to this, is during the private ownership, we really accelerated our capital investments, so that we can infuse Lean manufacturing and the creation of single-piece mix model aligned production facilities by being able to infuse some new capital into the factories.

I mean, one example I'd like to allude is in Sedalia, Missouri, before, to machine the rotors of the compressors, it would take 4 weeks from raw material to finish.

And today, we can do that in 3 to 5 days.

We're able to do that because of new machines that we have in place in Sedalia.

And at the same time, clearly, that helps our working capital from a working process perspective.

So then also from a supply-chain or sourcing perspective, we started by creating a global commodity team that we were able to start leveraging our buy, from a global perspective, better.

That was not existent before.

And now what we have done is, over the past 18 months, really infuse tremendously the value-added, value engineering process perspective that really goes after that 70% of cost of goods sold that is really the place where our VAVE efforts are attacking then.

We have incredibly, I mean, numerous examples on how we're driving this.

And then from an accelerating growth perspective, I'll say that the big difference that we're doing now is we're really very focused on innovation.

I spoke about being close to our customers.

It's something that we live every day.

We go to [Gamba].

We actually have our team really with the customers, really understanding the unmet needs and then developing new products that are really attacking those unmet needs.

And we gave some examples here in the presentation today with the Robox Energy, Thunder Pump, or even also our CRV Pump on the Medical side.

So the innovation is really coming across, and we're very excited where we are from that perspective and the future that, that will drive.

So obviously, I think, Nathan, I get very excited with our strategic imperatives, and I could go for hours talking about this, but I don't know if that gives you a little bit of color.

And any other questions you have, clearly let me know.

We'll spend some hours on it after the call today then.

I'm going to go and ask one on the Medical side.

Just a little bit of noise there going on with like 1 customer in drill sourcing.

But maybe if could talk about what you think that the long-term growth rate of the market is there and what you're opportunity is on the liquid side.

Yes.

So definitely, the long-term -- we -- over the past 2 years, we have invested in our Liquid Pump & Liquid Handling solutions.

That allowed us to increase our addressable market by 65%.

So now we're able to provide our products to a much larger base perspective.

The way we'd like to think about it is that we always plan to be on this transition in 2017 and part of 2018.

The things that we're working on, on building the momentum within the Liquid Pump & Liquid Handling solutions so we can become a total solution provider is really going to come to fruition in the later part of '18.

We have some very nice projects that we're working with some of our customers.

Many of them pharmaceutical companies that we're focused on, call it, drug concentration, monitoring systems and areas that we know from a life and lab perspective is going to see some better growth momentum than what we saw on the gas pump side of the market.

Obviously, we still have a good core gas pump market.

We're going to maintain that and invest.

That's why we launched the CRV Pump.

But from our perspective, Nathan, to the question of the potential, we said that when we were a gas pump provider, we were a player of a $700 million market.

Now that we have a Liquid Pump & Liquid Handing solution, we're a player in a $1.2 billion market.

So that kind of gives you the opportunity of the increase in terms of the market scope that we have done.

And if we had a leadership position before in the gas pump, we believe that we can have also a leadership position on the Liquid Pump & Liquid Handling solutions.

And the next question comes from Joshua Pokrzywinski with Wolfe Research.

Welcome back to public market, sir.

Just a couple of questions, following up on that pricing theme from earlier.

Vicente, when you talked about double-digit price opportunity in the upstream side over time, if I'm remembering correctly, kind of peak to trough pricing there was in the 10% to 15% range.

So double-digit wouldn't be, like a historically out of context number, correct?

Yes, that's correct.

That's exactly right.

And did any of that show up in the quarter?

It sounds like most of that was directed at the second half.

So the strength we saw in 2Q not necessarily pricing only yet.

That's right.

We saw a little bit, but as I've said, continue building the momentum for the second half.

Got you.

And then just a follow-up on the Industrial margins.

If I remember from your prior public iteration, margins were, call it, 800 basis points lower apples to apples.

And I think everyone, outside of the big Swedish competitor there, would have said that mid-20s EBITDA margins were kind of an unassailable position without a much different mix shift, I guess oil-free being the big driver of that.

Is it your opinion that you guys can get to something close to that?

That's clearly what your intimating.

With I still think a -- probably a suboptical -- suboptimal mix.

Is that a fair statement?

That's exactly right.

That -- you -- even on that, yes.

Got you.

And is there -- but is there room to improve that mix over time, I guess, organically or inorganically?

Exactly, that's exactly right.

Yes.

So definitely with the current mix, we see that potential to be in exactly the numbers that you just referred.

And as we are launching some new product lines within the oil-free market like the Ultima compressor that I mentioned, that mix could change even better.

And the next question comes from Brian Drab with William Blair.

Todd, just first on the Medical side, I just want to build on Nathan's question there.

Can you talk at all about any competitive response that you're seeing from some of the players on the liquid side?

They obviously should be a little bit nervous that a high-quality company like Gardner Denver is making a big push in the liquid side.

So have you seen any competitive response?

And then longer term, shouldn't this be a mid-single digit or better growth business for you regardless of what the industry is doing given this seems like a big white space opportunity for you on the liquid side?

This is Todd.

I'll take a shot, and Vicente can add on if he wants.

But we think this long term is a mid-single-digits kind of play.

The market should be growing that.

We'd also think with the new opportunity and expanded market, that Vicente mentioned, gives us share growth opportunities.

I would say that the cycle time is a little bit longer in this business, and it may take a little while to get some traction.

But that clearly will enable us to grow faster.

We think then, hopefully, the market rate grows.

And there's not a lot of large competitors in that space.

And we think that given our brands and #1 position on the gas side that we can take advantage of that going forward.

Okay.

And then just one more question on -- shifting back to the Energy segment.

Can you talk about the -- how we should model incremental operating margin going forward?

And maybe within a framework of what I think about as the 4 major components of your upstream business, and in terms of the OE, frac pump, the OE mud pump, the aftermarket for each of those businesses, those business lines.

The relative margins of each and right now, there's a lot of aftermarket activity.

But I think, contrary to what you see in a lot of companies, the aftermarket is actually, in my understanding, slightly lower-margin than your OE, the associated OE sale.

So can you kind of clarify how the margins stack up and within those buckets, and help us at all in how we should model incremental margin?

Yes, Brian.

So I -- from the second question first, we -- we're not counting on mud pumps.

And we're -- what we have, I mean, clearly, we're getting orders on frac pumps.

But it's not, what I would say, still at the super strong level that we expect it could get back in -- in later in 2018.

I mean, having said that, in terms of orders, we have over 1 million horsepower of orders.

And when we look at kind of what some of our competitors are doing, they're not close to that.

So we're getting some good orders from a frac pump, but I still don't feel that, that is enough based on the useful end of life of the frac fleets out on the market.

So my expectation is that we'll continue to see momentum on the aftermarket.

And the way we model is that we'd still be at that, call it, roughly 80% aftermarket and on the upstream side, of course.

From a flow-through perspective, I think it's good to see -- what we have seen is a sequential improvement from a flow-through perspective Q1 to Q2.

And we see anywhere between kind of mid-30s flow-through that could be potentially modeled here.

Okay.

And then just one more quick follow-up.

It's mainly aftermarket now; if the OE starts to come back, that's actually directionally better for incremental margins.

Is that true?

That's exactly true.

That's right.

And as that's all the time we have right now for questions, I would like to return the call to Vicente Reynal for any closing comments.

Thank you.

So as this marks our first call as a new public company.

We wanted to provide a great degree of transparency and color, as we are very committed to best-in-class Investor Relations and helping the financial community understand our company.

As you can see, we're incredibly laser-focused on consistent execution of our simple and straightforward strategy.

So for now, thank you for your interest in Gardner Denver, and have a great rest of the summer.

Thank you.

Thank you, guys.

Thank you.

The conference has now concluded.

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