格南登福 (IR) 2017 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Gardner Denver Third Quarter 2017 Earnings Conference Call.

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

At this time, I would like to hand the conference over to Vik Kini, Head of Investor Relations.

Please go ahead, sir.

Thank you, and welcome to the Gardner Denver 2017 Third 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 third 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.

Thank you, Vik, and good morning to everyone on the call.

I would like to start with a brief overview of our third quarter highlights on Page 5.

As you can see from both our top line and profitability results, we delivered a very strong third quarter highlighted by 40% revenue growth and over 600 basis points of adjusted EBITDA margin expansion, with over half coming from gross profit.

This now marks the fourth consecutive quarter of triple-digit basis points adjustment EBITDA margin expansion as the teams continue to execute the strategy we deployed and drive those value-creation initiatives that are key to unlocking Gardner Denver's full potential.

Consolidated revenues for the third quarter were $649.6 million, up 40% versus prior year and up 38% excluding FX.

With a strong revenue performance and a continued execution of our operational efficiency initiatives, we were able to deliver adjusted EBITDA of $164.7 million in the third quarter, which was an 85% improvement versus prior year.

In addition, we continue to see strong flow-through resulting in adjusted EBITDA margins of 25.4% in the quarter, which was 620 basis points higher than the prior year and 260 basis points sequentially versus the prior quarter.

The progress is evident across all 3 segments as Industrials showed triple-digit basis point margin expansion for the sixth consecutive quarter, Energy delivered in excess of 1,600 basis points of margin expansion and Medical remained relatively flat despite the expected negative revenue comp from the ongoing customer transition.

Cash performance followed a similar trend as the company delivered free cash flow of $54 million in the quarter, which was up nearly 210% versus prior year.

Given our performance in the third quarter, which saw double-digit orders growth versus prior year for all 3 of our segments and solid operating leverage, we're increasing guidance for 2017 adjusted EBITDA to $550 million to $560 million, which at the midpoint represents a $35 million or 7% increase versus our previous guidance.

As our first year as a public company, I continue to be very pleased with the ongoing transformation of our business and the broad-based execution of our teams.

This performance continues to demonstrate that Gardner Denver is emerging as a premier industrial company with multiple levers for success moving forward.

Turning to Page 6. I would like to give a brief update on our strategy as I feel it is critical to emphasize the basic principles that the company is executing on a daily basis.

As I described on our call last quarter, we established a simple yet powerful strategy that will unlock the value and potential that was inherent in our underlying businesses.

The strategy is meant to engage all 6,300 of our employees to drive actions across 4 basic principles: building and deploying talent, expanding margins, accelerating growth and efficiently allocating capital.

As our employees are embracing being owners of Gardner Denver after the $100 million equity grant at the IPO, our first engagement initiative is focused on net working capital.

In the third quarter, we completed a broad-based education and process improvement training effort to ensure our global employees understand the basics of net working capital and why it is so important for the company.

We believe it is crucial for myself and all of our management team to be close to our employees to create this level of engagement, whether it is our CFO, Todd, training 150 business leaders on net working capital or me meeting with over 1,500 associates across 15 locations in the third quarter alone.

It is important that we're leading our teams at the point of impact to create a long-lasting cultural transformation.

The second aspect of our strategy is expanding margins.

We continue to see opportunities to invest in talent and upgrade our capabilities.

One particular area of progress in the quarter was the completion of our procurement center of excellence in our Czech Republic shared service center, focused on centralization of core commodity buys.

This was an area we saw lacking in our European business and a -- and also an opportunity then to drive further value creation in our sourcing activities.

We fully believe that we need to continue to keep investing in talent and processes to achieve ongoing margin expansion.

And with another 620 basis points of adjusted EBITDA margin expansion in the quarter, we do believe these efforts are paying broad-based dividends.

The third leg of our strategy is accelerating growth.

I'm very happy to report that one of our core innovation efforts, the iConn, which is a cloud-based platform, is now live in the field with a direct focus on many of our compressed air applications we're selling in Americas, Europe and Middle East.

The reception thus far has been very positive, and we feel that this can be a key differentiator for the market as the use of open IoT standards allows for proactive management of complete compressed air installations, resulting in a much better efficiency and savings for our customer base.

Equally exciting is that we are now taking this technology to our Energy and Medical segments to improve the customer experience for our wide customer base in these diverse end markets.

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

We continue to fund internal profitability and growth initiatives with a keen eye also to external uses of cash, most notably strategic M&A.

I can report that we continue to work our funnel and prudently evaluate opportunities, being very mindful of strategic fits and returns.

In conclusion, we continue to execute on our simple yet balanced strategy.

While we are pleased with our third quarter results, we know that there is further improvement ahead of us as we build a highly engaged, performance-driven team and continue to drive ongoing profitable growth.

I will now turn the call over to Todd to take us through the third 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 Q3 as-reported revenues were $649.6 million, up 40% compared to 2016 and up 38% when excluding FX.

This now brings year-to-date revenue to $1.7 billion, a 26% improvement over prior year on both an as-reported and ex-FX basis.

Our Q3 performance speaks to the broad-based performance of the portfolio and the relative health of the underlying end markets.

In fact, orders of $606 million for the entire business was up 27% on a reported basis and 24% when excluding the impact of FX.

Each of our underlying segments saw strong double-digit order intake growth versus prior year, providing momentum as we enter the fourth quarter.

Our Q3 adjusted EBITDA was $164.7 million, up 85% compared to the same period in 2016.

Our year-to-date adjusted EBITDA stands at $388.9 million, a 54% increase over 2016.

Q3 marks the fourth consecutive quarter where we have seen adjusted EBITDA and margins increase on a year-over-year basis.

In addition, margins improved 620 basis points versus prior year and 260 basis points sequentially versus Q2.

On a segment basis, we continue to be pleased with the progress that we are seeing across the portfolio as our teams remain committed to improving their margin profile while balancing ongoing growth.

Industrials adjusted EBITDA margins improved 100 basis points versus prior year.

Energy delivered 1,670 basis points expansion, and Medical was flat on margins at 28.1% despite slight revenue declines due entirely to the expected dual-sourcing customer transition.

On a GAAP basis, we're reporting Q3 net income of $28 million or $0.13 per share on a diluted share count of 208.1 million.

Q3 GAAP net income included $48.2 million of pretax expenses for a loss on extinguishment of debt, stock-based compensation and other fees related to the IPO and public company financial reporting compliance.

We delivered adjusted net income of $85.2 million and adjusted earnings per share of $0.41.

This marks a 173% improvement over the prior year of $0.15 per share on 151.3 million shares.

A full reconciliation of our Q3 and year-to-date GAAP net income and earnings 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 will spend a few minutes on our cash and leverage position.

Starting first with working capital.

We saw the third quarter level of working capital as a percentage of LTM revenues decrease 110 basis points to 30.8% as compared to 31.9% in the prior year.

While the year-over-year improvement is encouraging, we are just getting started here and fully expect to see continued momentum as we finish fourth quarter and move into 2018.

Free cash flow for Q3 was $54.3 million, an improvement of 210% versus prior year and was comprised of $63.9 million of cash provided from operating activities and $9.6 million of CapEx spend.

In terms of our capital structure, in Q3, we completed a full refinancing of our U.S. dollar and euro term loan facilities with a recharacterization of debt levels between the 2 facilities, rate reductions on both facilities and maturity extensions for both to July 2024.

The refinancing is expected to generate annualized cash interest savings of $18 million based on current principal balance and LIBOR rates.

It's important to note that these interest savings are incremental to the savings we are seeing as a result of the IPO and debt repayment that was executed in May of this year.

At the end of Q3, our leverage profile significantly improved to 3.2x net debt, representing an improvement of 0.6 turns versus Q2 and a full 1-turn improvement over the past 4.5 months since May when we IPO-ed.

Overall, we ended Q3 with $303 million of cash, resulting in $737 million of available liquidity.

We continue to remain comfortable with our overall liquidity position and feel we are well positioned to balance future investments, M&A and further debt paydown.

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

Thank you, Todd.

Moving to Page 10.

I will start with Industrials segment.

Our third quarter performance continued the positive momentum we have seen all year in our larger geographic end markets.

In addition, we saw continued profitability improvement, marking the seventh consecutive quarter of solid year-over-year margin improvement.

The Industrials segment third quarter order intake was very strong at $294 million, up 14% as reported or up 11% excluding FX.

Revenues in the quarter were $288 million, up 9% as reported or up 6% ex FX and yielding a book-to-bill ratio of 1.02.

In terms of the product lines, all 3 air compression technologies saw revenue improvement in the quarter, with solid high single-digit growth in core oil-lubricated compressors and strong double-digit growth in both blowers and vacuum technology.

As far as the regions, starting first with the Americas, we saw solid double-digit orders and revenue increases in the third quarter across the entire suite of products.

In our European region, we also saw solid performance as revenues were up low single digits while order intake was up high single digits.

As we have seen for much of the year, the demand for core products are leading the way, and we are very encouraged by the progress we're seeing in targeted initiatives like revenue growth in the Middle East and order intake for oil-free technology.

Specifically in oil-free, I would like to highlight the progress we're making on our newest product offering in this category, the Ultima oil-free screw compressor.

The Ultima is a state-of-the-art offering in the $3 billion-plus oil-free market that provides greater than 13% energy efficiency as compared to currently available oil-free offerings, with a 40% reduction in size and much lower noise levels.

I'm pleased to report that we have taken multiple orders for Ultima units in Europe and Middle East where we launched the product earlier this year.

These wins are penetrating end markets like bioprocessing, pharma and food and beverage, which we view as higher-growth end markets and provide continued runway for industrial growth as we look ahead to 2018.

Finally, moving to Asia.

The results were in line with our expectations.

Revenues did show slight declines in the quarter.

However, orders in Asia saw great momentum as the region was up double digits, resulting in a book-to-bill ratio of approximately 1.2.

And we believe the initiatives we have deployed in our reset of the region are definitely starting to see some very good traction.

Moving to adjusted EBITDA.

Industrials delivered $63 million, up 10% ex FX.

As a percentage of revenues, third quarter adjusted EBITDA was 21.9%, 100 basis points better than the same period in 2016.

Sequentially versus the prior quarter, margins were slightly down by 50 basis points, which we attribute to slightly lower-margin profile from our recent LeROI acquisition and European summer seasonality.

Regarding LeROI, as we execute on our initiatives around growth initiatives, lean manufacturing, sourcing and VAVE, we expect to migrate the LeROI margins to the industrial profile over time.

On a year-to-date basis, this now brings adjusted EBITDA to $173.7 million and margins to 21.2%, which reflects 12% local currency growth and a 180 basis point improvement, respectively, versus prior year.

Moving next to the Energy segment on Page 11.

As the numbers show, we had strong, broad-based quarter benefiting from continued activity level increases in upstream energy as well as a solid execution on both projects and our core book/ship business on the downstream side.

The Energy segment third quarter order intake continued to be very robust at $251 million, up 46% ex FX.

While the orders percentage growth is comparatively lower than what we saw in the first and second quarter, it is worth noting that we're now starting to comp more robust upstream energy figures from the second half of 2016.

Revenues in the quarter were $301.6 million, up 116% ex FX.

In addition, third quarter revenues were up 26% sequentially versus the second quarter.

Our aftermarket performance, which is core to our strategy, continued to be very strong as well and it's up 107% year-over-year.

Aftermarket now comprises 55% of our LTM revenues, which is approximately an 800 basis point improvement from the end of 2016.

Activity levels in the upstream side continue to be very robust.

Order intake in upstream energy increased over 120% versus the prior year, building on the first half of the year which was up in excess of 500%.

Most notably, order intake did not slow down in the quarter as we continue to book, on average, approximately $50 million of orders per month.

Revenue performance followed a very similar trend as upstream revenues increased by over 250% in the quarter, building on first half of 2017 where the increases were in excess of 275%.

In terms of the fundamentals in the upstream energy space, we continue to remain optimistic as we head into the fourth quarter and look ahead to 2018.

Given our business correlation to activity and intensity levels, we're encouraged by the increasing trends in hydraulic horsepower utilization, lateral lengths, frac stages and proppant usage.

In addition, drilled but uncompleted well count has sequentially increased every month this year and now stands in excess of 7,200 wells compared to 4,900 at the end of 2014.

These trends support the dynamics we currently see in our upstream energy business, which continues to be approximately 95% fracking-oriented, with aftermarket comprising about 80% of the overall sales.

We also saw solid collective mid and downstream performance, with revenues up double digits in the quarter.

The largest driver was the downstream business, which saw strong execution in the quarter.

As a reminder, the downstream business, along with the midstream business, to a lesser degree, is the one component of the portfolio that has longer-cycle projects that tend to be much larger in size from a revenue perspective.

The second half of the year historically tends to be much stronger on project shipments.

And as you may remember from our previous call, 2016 had a bit of an anomaly whereby the majority of these projects shipped in the fourth quarter due primarily to customer delivery requirements.

In 2017, we're seeing a much more equitable spread of those projects between third quarter and fourth quarter.

A particular highlight on the Energy side is shown on the page for a specific vacuum system that the team booked in the third quarter.

This system is for use in a specialty chemical facility and marks the first time Gardner Denver is building a project of this kind, utilizing both NASH vacuum liquid ring pumps and blower technology from our Industrials segment on the same engineered system.

In addition, this is the first major project to be built in our downstream energy's India manufacturing facility, leveraging technology from across the business to innovate and bring differentiated solutions to our customers.

The Energy segment delivered adjusted EBITDA of $98.6 million, up 343% ex FX.

As a percentage of revenues, third quarter adjusted EBITDA was 32.7%, up 1,670 basis points.

On a year-to-date basis, this now brings adjusted EBITDA to $199 million and margin to 27.7%, up -- 183% ex-FX growth and up 950 basis points, respectively, versus prior year.

Moving next to the Medical segment on Page 12.

Order intake was solid at $61.1 million, up 17% ex FX versus prior year.

The orders performance reflects very good momentum across the core medical product portfolio, and we're also starting to see increased traction on our growth initiatives on our liquid pump and liquid handling products.

Revenues in the quarter were $59.8 million, down 1% ex FX.

It is worth noting that the dual-sourcing customer transition that we have previously mentioned heavily impacted the growth rate in the quarter.

If that impact is excluded, FX-neutral revenue growth in the quarter was 7%.

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

The example in the bottom-right corner of Page 12 is for our multichannel liquid syringe pump, which was recently selected for a diagnostic application in genomic sequencing that is ultimately being used for virus, cancer and pharmaceutical research.

Adjusted EBITDA performance for the quarter was $16.8 million, down 1% ex FX, but we still maintained 28.1% adjusted EBITDA margins, which were flat to prior year.

On a year-to-date basis, this now brings adjusted EBITDA to $46.9 million and margins to 27.3%, which are up 5% ex FX and up 130 basis points, respectively.

With that, let me turn it back to Todd to provide an update on our 2017 guidance.

Thanks, Vicente.

Slide 14 provides some key highlights for our 2017 guidance.

Due in large part to our year-to-date performance as well as continued confidence in the demand environment, we are raising our total year adjusted EBITDA guidance to $550 million to $560 million.

At the midpoint, this represent a $35 million increase or 7% from the midpoint of our previously stated Q2 guidance of $510 million to $530 million.

It's also worth noting that this increase will require solid Q4 performance year-over-year.

This is against the strong performance in the fourth quarter of 2016 that was driven by large long-cycle projects, as Vicente described earlier.

We've revised our expectations of CapEx to be in the range of $50 million to $60 million.

This does not change our view moving forward in terms of investing in growth and value-creation initiatives, and we believe that approximately 2.5% to 3% of revenue is the right level for CapEx for this business.

We expect year-end leverage to be approximately 3x, driven by continued free cash flow generation and adjusted EBITDA performance.

We also expect our average diluted shares outstanding for the total year to be 188.2 million shares using share count and share price as of September 30 for the balance of the year.

And now back to Vicente to wrap things up.

Thank you, Todd.

So moving to Page 15.

We're very pleased with our third quarter performance as we saw improvements across the board for revenue growth, margin expansion, cash generation and leverage reduction.

As we look ahead for the fourth quarter, we're focused on finishing the year strong with continued commercial and operational execution and creating ongoing value for our shareholders.

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

(Operator Instructions) And your first question will come from Mike Halloran of Baird.

So let's turn to the Energy side.

Just one, could you talk a little bit more about the sequential trends your saw through the quarter?

I know you gave some dollar numbers on a month-to-month basis, but how did that track sequentially?

And then also, have you started seeing signs that the original equipment side of the fracking -- is that starting to accelerate as well?

Are we at that point in the cycle yet?

Mike, so sequentially we saw very good momentum on the Energy side.

You can see that from a revenue perspective.

We saw sequential roughly in the 20s in terms of momentum and also clearly with the profitability that came with it.

On the frac side, as we said, we still see order rates in that $50 million per month, as we put in the prepared remarks.

So we don't see the slowdown or the peak in this market at this point in time.

I think, in part, that has to do with some of the things that we have done, obviously, as we said in the past, investments that we have done within the aftermarket perspective, which is obviously the place where we continue to see the good, solid momentum that the team is delivering.

And then on the OE side?

And then on the OE side, we're definitely seeing some good wins, I mean, but still the split that we see in the upstream side is about 80-20, 80% aftermarket, 20% OE.

That didn't really change that much.

But obviously, you saw the momentum of growth that we saw on the upstream side.

So you can tell that we're definitely seeing some OE pumps for sure, and we're -- as we said in the past, I mean, we're ready for when that wave of OEs will come, which we think is going to be in 2018.

That makes sense.

And then on the margin profile on the Energy side still, obviously, very robust year-over-year performance there.

Could you talk about sustainability from that level?

Obviously, you have some packaged stuff in there from the downstream side that probably helps the margin profile.

But maybe talk about how you think that tracks going forward and if there's anything that you don't think is sustainable in that third quarter number.

So that's a good point on the large packaged -- on the downstream side, Mike.

As you mentioned, this year, we're seeing more equitable split between Q3 and Q4 compared to last year that it was kind of more on the Q4 side.

But having said that, I mean, the flow-through and the momentum we see on the revenue due to the operational initiatives and the operating leverage that we're having, it's coming in pretty strong.

We also kind of saw some good momentum on price as well in the third quarter on the upstream side.

So all cylinders are hitting on high gear now at this point.

The next question will come from Andrew Kaplowitz of Citi.

Vicente, so just going back to upstream energy, obviously strong numbers.

Revenue was up greater than 250%.

North American rig count, up a little more than 100.

You've talked in the past about having 50% more content this cycle than last cycle, but, obviously, you talked also about having more difficult rig count comparisons moving forward.

So has your confidence level risen that you should be able to record still double-digit revenue growth in upstream in '18 even if rig count is flat to down?

And then how much of the strong growth would you say is share gain that could be sustainable moving forward?

Yes.

Thank you, Andy.

So I think the way I like to think about it is that if you go back to the last peak in 2014, there was about 1,800 rigs.

Now there's about 900 rigs, and look at the growth momentum that we're seeing comparable to what we had back then on the frac side.

Because, as we said in the past, 2014 had some drill pumps that we're not seeing today as we're basically 95% frac.

So even on that downturn of the rig count, we're seeing some very good momentum in growth, and that is really driven by what we have said all along about the intensity, number of stages getting accelerated and the proppant use that is pushed through the well.

So we're definitely seeing some good momentum on -- from that rig count.

And at the same time -- moving now into '18.

If we continue to look at the same trends, we see that, on a flattish rig count, we will continue to see some growth on the frac side as the intensity continues to expand due to longer laterals.

And the one thing that we pay attention to as well is what they call the drilled but uncompleted wells, which, obviously, as we reported, we have seen very good momentum.

I mean, we're sitting now at a peak that hasn't been seen before of 7,200 DUCs, drilled but uncompleted wells, that -- compared to back in 2014, there was roughly 4,000 or 4,200.

So clearly, the decline in the rig count from '14 to '16, for me, has been kind of obvious from the perspective of efficiencies are getting better.

But the good thing in our side is that intensity continues to grow, and that is what drives our business.

Okay.

And then you mentioned the slight industrial adjusted EBITDA margin decline sequentially despite higher volume.

You talked about it being a result of European seasonality and a recent acquisition, but mentioned that you should see improvement moving forward.

So how should we think about incremental margin in industrial moving forward?

Do you have a bit more of a headwind from the acquisition moving forward?

Or could you resume stronger incremental margin growth relatively quickly?

Yes.

So -- thanks.

And so I think we definitely -- moving forward, the way we like to view it is that we'll continue to deliver year-over-year basis point expansion.

And it's something that I said -- as I said in my remarks, I mean, this is now the seventh consecutive quarter of positive basis point expansion and actually the sixth quarter where we have seen now -- consecutive quarter we have seen triple-digit basis point expansion.

So I think the momentum continues.

We see, as we look forward -- I mean, the LeROI was really a great acquisition from the perspective of mission-critical technology with very good aftermarket that we can definitely grow.

And obviously, the characteristics of -- there's a lot that we can do in that business to really improve it from a lean manufacturing and a sourcing perspective.

In the third quarter alone, our team leveraged the spend that we have and moved from being a basically kind of Ohio, U.S.A.-centric supply base to one that is really more what we have from a global scale.

And that alone is going to give $0.5 million to $750K of annualized direct material savings, and that was just in the quarter.

So we see better -- good momentum here moving forward.

And the way we like to view the expansion in Industrials is really more on a year-on-year basis.

And Vicente and Todd, is it possible to quantify how much the acquisition diluted margin in the quarter?

I don't know that we'll quantify it directly, but let me see if I can help you for a second.

When you bridge the 22.4% down basically to 21.9% roughly, roughly 1/4 of that you can attribute to the LeROI acquisition.

We had some project business -- large project business, which tends to have slightly lower than profile margins and some seasonality.

That would be the bridge to the rest of the wreck there.

As Vicente said, we're not really concerned about it.

We still expect major expansion as we finish the year in total, and we would expect to be on a track that we stated previously, pushing towards 25% in the midterm in that business.

The next question will come from Joe Ritchie of Goldman Sachs.

This is Ashay on for Joe.

So I guess just digging into the Industrials segment for a second.

You've seen pretty strong order growth for like the first 3 quarters of this year.

Can you talk about like how that is expected to translate into revenues over the next 1 to 2 quarters and maybe even address the kind of pricing that you're seeing on these orders?

Like is it better than the 1 point or so that you were realizing in the first half?

Yes.

So I'll -- I mean, obviously, the 14% as-reported orders growth momentum or 11% on local currency, solid momentum in the quarter across really all the regions.

And I mean, as you know, the Industrials segment is really primarily short cycle, so a lot of that kind of turns here fairly quickly within the next couple of quarters.

So I think we'll see some -- the majority of that here turn, call it, Q4, Q1, and we're building some good momentum here also for, obviously, the rest of '18.

I want to follow up to that too on pricing.

I think that we have a pretty standard model, and I don't think you'll see huge differences than what you've seen year-to-date, although we are coming into some annual pricing cycles as well.

So we should see some benefit from that going forward into Q1.

Yes.

And as we said in the past, we've done a lot of work to improve our internal processes around pricing, and we're definitely seeing that pricing read-through of 1 to 2 points in the business.

Got it.

And could you maybe just comment on like some of the fluid end price increases, I think, that you talked about in the last call as well?

Like have you put those through?

How are they like being taken by the market, et cetera?

Yes.

So we like to say that -- I mean, we -- the way we have positioned our business on the upstream side is one that is really to deliver the value that these customers -- or that our customers are looking for.

And what they want is they want high utilization and high uptime.

So as long as we deliver that to them, we're going to be able to command a premium price point.

And so far, we've been able to do that.

And so when a customer wants a fluid end in 24 hours, we can deliver that.

When a customer wants a fluid end in a week, we can definitely do that.

And as you know, our lead time is definitely best in class not only on the fluid end but also on pumps and everything -- and all the other components that we have in our business.

So we've done extensive work on our internal manufacturing processes to really be very flexible and have a rapid delivery to our customers.

And that, obviously, leads us to a good pricing.

Cool.

And I guess, just finally, your working capital efforts seem to be like surprising to the upside every quarter.

So can you maybe share with us some targets, like 1-year, 3-year targets that you have in terms of like working capital maybe as a percentage of sales?

Sure.

I think we are out in traffic a little bit with kind of our midterm targets.

And as of today, we're floating around 30%, and we have stated kind of a midrange target of roughly 25%.

As you've heard Vicente discuss, it's our really first big, major employee engagement initiative that we've launched in the third quarter.

And I can tell you that Vicente and I have been at all of the sites in terms of touching all employees and physically been in, I think Vicente mentioned, over 15 sites in the third quarter.

And that message has resonated, and people are developing quick win ideas around those topics.

And we think that we have focused on an employee-engaged culture now that's going to help us improve that all the way through '18 and help us towards that 25% kind of goal.

I don't think that's (inaudible), but that's kind of our midterm view.

The next question will be from Julian Mitchell of Crédit Suisse.

This is Lee Sandquist on for Julian.

Within Energy, you touched on this briefly, but how did pricing trends progress throughout the quarter?

And especially on the upstream side, how do you expect them to end the year?

Yes.

We saw there kind of fairly sequential -- obviously, as we progress into the year, we said that we'll definitely see very good, stable price, with the increased momentum that we're putting out, again, as long as we can deliver to customer expectation.

So definitely, we continue to see very good momentum there.

Okay.

And in terms of Industrials, can you just touch on the order trends in small versus large compressors?

A few of your competitors have noted a tick up in the bookings in the latter.

Repeat the question, Lee, one more time.

You said on the large...

Small versus large compressors.

Yes.

We don't really participate on these kind of large-scale compressors like, let's say, maybe some of our other competitors are doing.

As we have said in the past, I mean, we definitely like how our compressor -- I mean, really, when you look at Industrials or the compressors, blowers or vacuums, I mean, we're kind of very -- particularly have good, strong niche segments that we play really well, and that's why we like our business.

From an oil-lubricated, we're seeing some very good momentum on small and medium oil compressors.

Obviously, very great progress on vacuums and blowers, as I alluded on the earnings -- on the pre-comments at the beginning.

And obviously, excited with the innovation that we're launching with entering the oil-free segment end market.

And obviously, that's given us some very strong orders.

Understood.

And in terms of free cash flow conversion, can you just remind us on the medium-term targets?

And will the working capital efforts be enough to bridge the gap?

Yes.

There's a couple of comments just to give some color on that.

We do expect to have 100% kind of net income, free cash flow -- free cash flow to net income kind of view going forward.

A couple of things will support that: one, the wind-down of our restructuring programs that have used some cash.

We've said that those will primarily finish at the end of this fiscal year.

We also, as you mentioned, have a strong focus on working capital, and we expect to benefit from that for the next 5 quarters at a minimum.

And then also, as you noted in our comments, we've refinanced the debt successfully, which clearly is driving down our cash interest costs.

We still have the ability to leverage some NOLs in the U.S., which will suppress cash taxes into '18.

And then also good discipline around CapEx, which we've said we will be methodical about our 2.5% to 3% spend on an annual basis.

So all that will lead to strong free cash flow conversion.

The next question will come from Nathan Jones of Stifel.

Guys, back to Energy for a minute.

You talked about $50 million order a quarter being pretty flat, the downstream, midstream shipments pretty evenly split between 3Q and 4Q.

Is there any reason why we shouldn't expect 4Q Energy revenue to be roughly that $300 million that you got in 3Q?

I mean, that's probably about the right way to view it, Nathan.

And obviously, when you said $50 million, it's actually $50 million per month on the upstream.

Per month, sorry.

I've just taken $100 million a quarter off you.

Back -- just pre IPO, you guys talked about thinking that maybe you couldn't get back to the previous peak on margins in Energy because you didn't think pricing was going to come back as strong as it had been in the previous cycle.

You've talked today about getting price sequentially, pricing being better probably than you had expected.

Has that changed your view on maybe where peak energy margins can get to?

Well, I think one of the things to think about too, Nathan, as you remember, back in the last peak, we had a lot of drill pumps as well.

And I think what we alluded to the fact is that the way we get to better margin is -- and just as a reminder, I mean, drill pumps are the ones with the highest margin as we have mentioned to you in the past.

And what we're saying is that -- I mean, we're definitely getting past beyond that even without the drill pumps, and that really speaks to the operating leverage that we have.

So what we were alluding in the past is that the mix is different.

But clearly, we have invested on capital, on manufacturing to really get to that process.

And obviously, because we can deliver and be a great support to our customers, we can command premium price.

Okay.

And then just one on the DUC count.

Clearly, if DUCs continue to rise, that's one thing.

If the DUCs would start to come down, if these wells got completed, that would obviously drive your revenues up.

What are your customers telling you about their plans to either continue completing wells at the same pace, ramp up well completion?

Just whatever insight you have from -- into that from your customers.

What we're hearing and what we're seeing, and obviously, we'll see more as some of our other customers continue to release, is that many of them are sold out already into the fourth quarter and really driving -- what they want to do is continue to drive more momentum.

But -- so I -- that gives us confidence that from a sequential perspective, we don't see the slowdown because many of them are already kind of sold into the same levels in the fourth quarter as what they did in the third quarter.

And some of them are alluding to already getting sold out capacity into...

Into '18.

Into '18.

The next question will come from John Inch of Deutsche Bank.

So could we get on the upstream side what were your orders growth this quarter?

And remind us what were they last quarter.

And then for all of Energy, what was book-to-bill this quarter and what was it last quarter?

Yes.

So the book-to-bill, I'll say that it's a little bit -- so book-to-bill last quarter was about 1.2.

Book-to-bill in the third quarter, it was about 1. And obviously, within the Energy side, there's a little bit of lumpiness because some large orders could be get booked in 1 quarter versus not the other quarter.

And so -- and then, John, what was your next question?

It was around...

Well, you had talked about -- I think you gave some color around upstream orders and order growth.

I'm just wondering, if you just look at upstream, what was the orders growth this quarter and what was it last quarter?

Yes.

So orders in the upstream side were...

121% up in Q3.

And in the prior quarter, it was 600% and before that, roughly 500% in Q1.

And obviously, I think the thing to keep in mind is that kind of the second half of '16, that's when we were starting to have a more tougher comp on the upstream side.

That's why we alluded to the fact that, on an absolute dollar, we're still seeing the same roughly $50 million per month order rates.

These orders all get fulfilled, based on your commentary, over the course of the coming year, right?

Is that the way to think about it?

So in other words, presuming this progression of the $50 million a month continues, you're kind of locking in already '18 other than growth rates that are likely to face pretty steep comps.

Is that the way to think about it?

So the way I like to think about it is that, typically -- I mean, these are kind of -- because of 80% being aftermarket, it is really -- I would say it ships kind of within the same quarter and obviously gives us some backlog.

But as we start to see order momentum on the new pumps, then we'll get the backlog to increase because the new pumps are -- have a longer lead time than, let's say, a fluid end.

I mean, a fluid end, we can deliver in a week to 2 to 4 weeks, and a new pump, it could be anywhere between 6 weeks to 8 weeks.

And we have good visibility with our platinum accounts, we call it, which give us forward demand.

And so we like the visibility at least in the 3- to 6-month time frame.

Vicente, you said 95% of upstream was frac.

For those of us who aren't energy aficionados, what's the 5%?

What's the rest of it?

It's what we call drill.

So we -- in the upstream side, we have our pumps, what we call the drill pumps.

They are co-located within the rigs to really push the mud for drilling the well.

And then the other product line that we have is what we call the frac, which is basically once you drill the well, the pressure pumping trucks will come in and they just push proppant to frac the wells.

And today, we're seeing that 95% of the revenue is really coming in from the frac.

And that 95% is 80% aftermarket, 20% new pumps.

And then that other 5% that we still see on drill pumps is really more aftermarket, which is an area that we're also investing today in the drill pump aftermarket.

And kind of what we're saying is basically that the drill -- the new drill pumps is not -- I mean, we're not expecting that to come for a while.

So there really are no new OE drill pumps in your mix today, right?

Is that...

That's right.

I thought you had alluded to that -- this was earlier in the discussion.

I thought you sort of had alluded to the fact that -- I don't want to use the word momentum.

I don't think that's what you said.

But you sort of implied there was activity there.

Is that because you are getting quotes for this or you're just -- your salespeople are sort of talking more positively?

Or what exactly is going on?

Like...

That's right, yes.

So definitely on the frac pumps -- so you have frac pumps and you have drill pumps.

And where we see the momentum or the quotation and a lot of the chattering is really on frac pumps.

If you go back to -- so -- and definitely, John, we can definitely go through more detail in terms of the horsepower that we saw added back in 2010.

But really, the frac -- age of those pumps is really beyond its useful life.

So that's why we will definitely see and we're seeing some pickup on new pumps for the frac.

Just lastly, in terms of Industrials, so you -- basically, the margins were down sequentially, and you effectively said your European -- you had issues with Europe.

Does that imply the U.S. margins were up sequentially in that business?

I forget what your commentary was about Europe.

You said it was -- I forget what you said.

Okay, yes.

So what we we're trying to say is that, sequentially -- if you remember, we made an acquisition called the LeROI, and so that created some of the sequential view in terms of the margin, as Todd kind of alluded here also on some of the questions.

And then also, sequentially, we had some kind of large projects that we shipped in the third quarter that obviously was not in the second quarter from a revenue perspective.

And what we mentioned on the European side is that, typically, obviously, it's just the seasonality.

It's just more vacation time and more holidays in Europe.

And keep in mind that within our industrial business, 50% of our volume is really -- or 40% and change, is really from the European side.

I guess one other thing I would mention again too is that we don't think that the improvement is necessarily linear all the time quarter-on-quarter.

But we do feel, on an annual basis, we will get significant improvement [VPY] and grow that margin as we look out in the next 12 to 24 months.

But ex Europe and ex this acquisition, U.S. probably was up sequentially.

Is that right?

That's right.

The next question will come from Bill Herbert of Simmons.

So of the close to 700 basis points improvement in Energy margins in Q3, how much was driven by downstream mix and how much was driven by upstream pricing?

Yes.

So the Energy -- the 17 -- almost 1,700 -- 1,600 basis point improvement, that's what you're referring to, right, Bill?

Quarter-on-quarter 700, I think, is what I'm looking at, from 26% to close to 33% in margins.

Yes.

So I think it was a very good equitable mix between the upstream side and the mid and down, Bill.

I think it's a good way to view it.

Okay.

But what I'm trying to get at, Vicente, is how much -- I'm trying to gauge the level of pricing traction that you're getting with regard to upstream.

So I understand the operating leverage component of it in terms of volumes.

But how much of that was price-driven?

I think the way you may want to think about it is that, on a blended way for upstream side, we're getting into the kind of low single-digit to mid-single-digit price.

And then I think you can take it from there, yes.

And that would be net price or gross price?

Net.

Got it.

That's great.

And then with regard to fourth quarter, you mentioned that you had kind of an imbalance last year, which drove the exceptionally strong surge in the fourth quarter where you generated like 30% margins versus '16 in Q3 of last year.

Is there any reason why margins in this fourth quarter would not be up year-over-year?

Year-over-year, there shouldn't be an issue.

I mean, it shouldn't -- nothing that could -- we will note.

Okay.

And last one for me.

I'm just curious, with regard to the Harvey-related dislocations to the refining value chain into the chemical value chain, if you've seen any pickup in inbound associated with the repair of that value chain.

No, not really, not yet.

I mean, there's definitely -- obviously, our mid and downstream teams are the ones that are really high touch with a lot of the petrochemical factories, and we're working.

There's been maybe some quotations, kind of uptick demand, but we still haven't seen the orders on that yet.

And the last question this morning will come from Josh Pokrzywinski of Wolfe Research.

I guess just staying on the Energy side.

I apologize, I jumped on a bit late, so if you already answered this, let me know.

On orders for Energy, book-to-bill was 0.8 in the quarter.

I guess, could you remind us seasonally what's normal there?

I know fourth quarter typically has some larger packaged projects that come in that kind of boost the revenue.

So could you just kind of remind us how that's seasonally phased in and if that 0.8 is kind of a normalized number?

Yes.

So typically, we get the large cycle orders in the first half of the year, and then you get those shipped in the second half.

So that's -- and that's exactly the way.

I think you're thinking through that well.

And is the 0.8 in the third quarter a normal number, a low number?

I guess I'm just trying to gauge how sustainable the revenue is.

That's fairly normal based on the large orders that get shipped in.

And keep in mind that, I think, we think about it too as -- yes, that's right.

So fairly normal.

Okay.

And then on the pricing front, I know people have asked this a few different ways, but I guess, given it seems like lead times are still reasonably long, have we seen the big step-function change in price on the upstream side and, from here, the gains are smaller?

Or could we still see another leap up?

I guess you probably have some visibility into that -- into the backlog.

Maybe you don't want to give precise numbers, but is the 2Q to 3Q change the biggest one or is there still more to come?

So we're definitely seeing the sequential improvement.

I mean, if you compare first half to -- I mean, quarter-on-quarter we see it.

First half to second half, we see it there.

But we definitely continue to see just stable pricing momentum as we move forward sequentially.

And ladies and gentlemen, this will conclude our question-and-answer session.

At this time, I would like to hand the conference back to Vicente Reynal for any closing comments.

Thank you.

And given that we're still a new public company, we wanted to provide a great degree of transparency and color as we're obviously very committed to best-in-class Investor Relations and helping the financial community understand our company.

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

So thank you again for joining the call today and your continued interest in Gardner Denver.

Thanks again.

Ladies and gentlemen, the conference has concluded.

Thank you for attending today's presentation.

At this time, you may disconnect your lines.