格南登福 (IR) 2018 Q3 法說會逐字稿

Good morning, and welcome to the Gardner Denver Third Quarter 2018 Earnings Conference Call.

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

I would now like to turn the conference over to Vik Kini, Head of Investor Relations.

Please go ahead.

Thank you, and welcome to the Gardner Denver 2018 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 Slide 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 Slide 3 of the presentation.

Turning to Slide 4, on today's call, Vicente and Todd will review our third quarter financial performance and segment results as well as our 2018 guidance.

We will conclude today's call with the 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.

I am excited to review our third quarter results.

Our team delivered another very well balanced quarter of positive year-over-year orders and revenue growth, with strong margin expansion and solid free cash flow generation.

All 3 of our segments continue to operate in relatively healthy end-markets, resulting in consolidated revenue growth of 6% versus prior year and up 7% on an FX adjusted basis.

Adjusted EBITDA grew 11% and margins expanded 100- basis points to 26.4% in the quarter.

Adjusted EBITDA increased 220- basis points on a sequential basis from the second quarter, with each segment showing meaningful improvement.

Moving briefly to the segments.

In Industrials, we saw solid revenue momentum continue across the 3 main geographies, with the Americas growing double digits, and EMEA and Asia Pacific growing single digits.

The growth is being driven largely by core technologies, like oil lubricated compressors and blowers, which grew high- single digits and double-digits, respectively, as well as some of our more niche technologies, like oil-free transport and marine.

Importantly, we also saw better aftermarket performance than what we have seen over the first half of the year, with growth coming from higher-margin parts and services.

The Energy segment continues to execute well.

On the upstream side, there continues to be a lot of discussion and noise about the Permian takeaway capacity and the impact on the market.

However, even with this, our upstream business grew revenues in the quarter by 6% and it grew orders by 9%.

The orders growth can be largely attributed to the continued efforts on consumables, innovation and market share penetration, which led to strong double-digit growth in the quarter.

We believe this level of growth is far in excess of the growth rate of the overall market and a testament to the market share gains our teams are driving.

Let me also remind you that this growth is on top of more than 250% revenue growth and 120%-plus order growth that we saw in the third quarter of 2017.

The mid- and downstream side of the business are continuing to see solid end-market dynamics around process flow application, and we continue to build backlog for 2019.

Specifically, with regards to revenue in the quarter and in line with what we discussed on prior calls, revenue was down collectively in the mid- and downstream businesses about 10%, entirely due to the timing of project shipments as compared to the exceptionally strong third quarter we saw in 2017.

We expect this dynamic to turn around in the fourth quarter, with revenues up in excess of double-digits compared to the same quarter in 2017.

The Medical segment continues to see strong organic orders growth in the third quarter of 21%, marking the 5th consecutive quarter of healthy double-digit orders increase.

The continued growth in backlog and solid execution we have seen in the Medical segment translated to 19% organic revenue growth in the quarter, which is the strongest quarter we have seen in the past 5 years.

The Medical team continues to win share, and we are encouraged by the progress we are seeing with multiple wins in the newer product categories of liquid pumps and liquid handling technology.

Turning to Slide 6, I would like to provide a brief update on how we are executing our strategy.

As everyone knows, there continues to be a lot of noise from a macroeconomic perspective on items like tariffs, FX, Permian Basin's transitionary capacity and other comparable dynamics.

As a result, we're driving tangible continuous improvement initiatives across all of our 4 strategic imperatives to support the delivery of our financial commitment.

First, on the margin side.

We're taking steps to reduce our structural cost base to provide lasting margin expansion.

We have previously discussed our Innovate 2 Value or I2V initiative.

The teams have now fully completed the first wave of I2V in terms of product turndowns, evaluation and project prioritization.

And we are now moving rapidly into product redesign and resourcing.

In addition, we are now starting our wave 2. And as we continue to move through the process, our initial estimate of more than $30 million of run-rate savings by year 3 continues to increase.

And we now see upwards of $45 million of run-rate savings by year 3.

In addition, as you may have seen in our financial statements, we did book some formal restructuring costs in the third quarter, which I will characterize as operational-related simplification and optimization.

We will continue to evaluate opportunities for optimization in the fourth quarter of 2018 and early parts of 2019.

On the growth side, we're taking a similar approach to process improvement to ensure our commercial teams are following a standard process around funnel management, KPIs and daily management.

Recently, we have launched a tool that we refer to as growth room, across entire business to formally train and standardize this commercial lean process.

And we have already launched 30 growth rooms across our different businesses.

We believe that the rigor and discipline that the growth room will bring, coupled with the efforts already underway from our improved innovation and imagination initiatives, will lead to a sustained market outperformance.

On the capital allocation side, we continue to make solid progress on cash generation and returning value to shareholders.

Third quarter free cash flow generation was $93 million or 13% of revenues.

Working capital, as percentage of revenues, continues to be down over 500- basis points from prior year levels.

In addition, we're improving many of our internal processes around cash management.

As a result, we decided to pay down an incremental of $152 million of debt within the quarter, this is on top of the $105 million we paid down last quarter.

We also utilized our recently authorized share repurchase program, and opportunistically purchased $5.6 million of shares within the quarter.

Next quarter, we expect to pay down another tranche of debt likely to be in the range of $50 million to $100 million.

Although we're not providing guidance on 2019, we continue to see multiple levers to generate cash and would expect to generate at least $400 million in incremental cash.

This will allow us to further pay down debt and, as appropriate, pursue accretive M&A and repurchase shares depending on our stock price performance.

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 Slide 8, I will review the company's financial performance.

Third quarter revenue was $689.3 million, up 6% compared to 2017 and up 7% when excluding the impact for FX.

Total orders of $647.5 million were up 7% and 8% when excluding the impact of FX.

On a book-to-bill basis in the third quarter, total company finished at 0.94, which is consistent with the normal seasonality seen in the business, where larger projects in our mid- and downstream businesses ship in the second half of the year.

Our third quarter adjusted EBITDA was $182.2 million, up 11% compared to the same period in 2017.

EBITDA flow-through for Gardner Denver in the third quarter was healthy at 44%.

On the topic of tariffs, at this time, we have fully evaluated the impacts of all announced Section 232 and 301 tariff implications, including all aluminum, steel and China implications.

In line with our expectations, we expect the full impact to be approximately $10 million to $15 million of annualized inflationary impact, of which approximately $1 million impacted the third quarter.

We are confident in our ability to offset this impact through ongoing productivity, sourcing actions and pricing actions within the business, much like we did in the third quarter.

We reported third quarter GAAP net income of $72.2 million or $0.35 per share on a diluted share count of 209.1 million.

We delivered adjusted net income of $102.7 million and adjusted diluted earnings per share of $0.49 on a share count of 209.1 million, which is a 20% improvement from the $0.41 per share on 208.1 million shares in the prior year.

Moving to Slide 9, let me spend a few minutes discussing our cash generation and leverage position.

As Vicente indicated earlier, working capital as a percent of last 12 months revenues improved 560- basis points to 25.2% as compared to 30.8% in the prior year.

Net working capital remains a focus for our organization.

We have seen sustained improvements throughout this year based on process improvements and are expecting further improvements as we move through the end of the year and into 2019.

Free cash flow for the third quarter was $92.5 million compared to free cash flow of $54.3 million in the prior year and included $103.8 million of cash provided by operating activities, less $11.3 million of CapEx.

Given our strong cash generation in the quarter combined with improving profitability, our net debt leverage profile improved to 2.2x at the end of the third quarter, representing an improvement of 0.2 turns from the prior quarter and a 2-point turn improvement since our May 2017 IPO.

We ended the third quarter with $269 million of cash and $614 million of total available liquidity.

We utilized ROIC as an internal measurement focused on operating cash returns, defined as LTM-adjusted EBITDA minus CapEx, divided by total invested capital, which equals net working capital plus gross PP&E.

Our actual ROIC finished the third quarter at 49%, an 1,100- basis point improvement over prior year.

The improvements we are seeing are a reflection of earnings growth plus high-quality investments and the improved discipline in net working capital and cash management, which we attribute to our ongoing engagement initiatives.

As Vicente indicated earlier, due to continued strong free cash flow generation and efficient cash repatriation, we were able to pay down $152 million of additional debt within the quarter.

We believe prudent gross debt reduction remains an important facet of our capital allocation strategy.

And as Vicente indicated, we will make another payment in Q4.

We also opportunistically utilized our share repurchase program within the quarter, repurchasing 224,000 shares for a total purchase consideration of $5.6 million, or an average price of $24.86 per share.

We expect to continue to utilize our share repurchase program in a similar manner moving forward as we see dislocations in our stock price.

Finally, on the M&A front, we continue to see an active and healthy funnel largely comprised of bolt-on targets, similar to the profile of deals we have executed over the past year.

We are currently in active due diligence on a handful of targets, and would fully expect to close at least 1 to 2 transactions between now and the end of the year.

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

Thank you, Todd.

Moving to Slide 11, I will start with Industrials segment, where we saw solid momentum on both orders and revenue growth.

Industrials segment third quarter order intake was strong at $313 million, up 7% as reported or up 8% excluding FX.

Revenues in the quarter were $320 million, up 11% as reported or up 13% excluding FX, where organic growth was 8%.

We continue to see good momentum on all 3 air compression technologies, as ore -- as core oil lubricated compressors grew high- single digits and blowers and vacuums collectively grew mid-single digits.

We are also starting to see the mix of revenue improvement.

While original equipment continues to be the strongest growth factor with double-digit growth in the quarter, aftermarket was also up single digits.

We will continue to expect original equipment to outpace aftermarket for the coming quarters due to the ongoing effort in innovation, demand generation and emerging markets, but the momentum on the aftermarket is encouraging and reflective of the efforts around some of our newer connected customer initiatives, like iConn as well as an expanded portfolio of aftermarket products.

From a geographic and end market perspective, the Americas continues to be the strongest region with high single-digit orders growth and double-digit revenue growth as we leverage backlog that was built in prior quarters.

EMEA saw orders and revenue growth in the mid-single digits, with core products trending largely positive and some stronger gains on more niche applications like compressors for marine applications, where Gardner Denver commands a leading position.

An example of a growing end-market that we see strong future growth potential from is the emerging aquaculture market in EMEA.

Encompassing such applications as fish farming, aeration and a variety of other process-driven functions, the aquaculture market is a multi-billion-dollar market, growing at an estimated 5% CAGR over the coming years.

And our new line of compact dry running engineered blowers serves the market needs well due to the enhancements in size, noise reduction and maintenance.

In Asia Pacific, revenues were up single digits, while orders were slightly negative due in large to China.

We attribute the China order dynamic largely to the continued noise around tariffs and the trade dynamics.

While this has created a bit of a wait-and-see dynamic for the local China market, we don't expect this to have material impact to the overall Industrial segment revenues, given the relatively small size of our China revenue base as compared to the overall Industrial segment.

In addition, while oil lubricated compressor order growth was down in the quarter in China, we actually did see growth in vacuum, which is very encouraging, given our efforts to increase our presence and share of some of our more niche offerings in that market.

The Runtech business also continues to operate very well as integration efforts are on track and both orders and revenue performance are well within our expectations.

Moving to adjusted EBITDA, Industrials delivered $72 million in the quarter, up 14% as reported and 15% excluding FX.

Third quarter adjusted EBITDA margin was 22.5%, which is 60- basis points up compared to the same period in 2017 and up 90- basis points versus the second quarter of 2018.

The year-over-year margin increase was driven by pricing, aftermarket growth and the initial impact of the I2V initiative that helped offset the known headwinds of tariffs, FX and the slightly diluted impact of the Runtech business.

We remain committed to achieving our mid-20s EBITDA margin target in the next 2 to 3 years and expect the fourth quarter to continue to show momentum.

Moving next to the Energy segment on Slide 12.

Overall, we had another strong quarter, led by execution in the upstream business despite the ongoing noise regarding the Permian Basin and initial execution on project backlog in the mid- and downstream components of the business.

The Energy segment's third quarter order intake was $261 million, up 5% excluding FX.

Revenues in the quarter were $299 million or flat excluding FX, leading to a book-to-bill ratio of 0.87.

Book-to-bill ratio being below 1 is normal for this business due to the typical seasonality in the back half of the year, where larger mid- and downstream projects see stronger shipments.

In fact, book-to-bill in the third quarter of 2017 was 0.83, so we continue to trend in a consistent manner.

Let me now dive into the components of Energy, starting first with upstream.

In general, we continue to execute very well, and you see that our revenue growth of 6% despite meaningful comps from 2017 in the upstream business.

In addition, there continues to be a lot of talk about the Permian Basin and concerns on what that means for completions activity.

I will characterize the Permian environment as seen as flattening of the demand curve, but not necessarily a contraction, since we saw well completions still growing in the month of September.

We also believe that the market appears to be somewhat bifurcated, with one side being frac service providers and E&Ps, who have committed pipeline capacity are doing fine, seeing solid activity and generally very resilient with pricing.

And on the other side are those providers trying to play in the spot market, having more challenges and, therefore, activity weakness.

In general, we don't expect this dynamic to really change for the next three quarters until incremental pipeline capacity comes online in the second half of 2019.

It is worth mentioning that the consensus market expectation is for this dynamic to be transitory.

In fact, a recent report is calling for completions growth in 2019 to be in the low 20s percent, while stage count growth is in the upper 20% in 2019.

This bodes very well for us as stage count is a good indicator of aftermarket and consumable demand, where we believe we are a leading player today.

In addition, a good leading indicator is the drilled but uncompleted wells, or DUCs count, which today stands at nearly 8,400 at the end of September and it is about 192 higher than the end of August, with the entire growth coming in from the Permian Basin.

The other leading indicator is the spread between WTI Midland and Cushing, which sits today at about $3 versus closer to $20 a few months ago.

All these indicators point to an ongoing expectation of an improving completions cadence as just mentioned.

Despite this market noise, we are very pleased with how we're executing as we deliver $167 million in orders, which was up 9% versus prior year and 11% sequentially growth versus prior quarter.

The most important driver of the growth continues to be our line of consumables, which grew strong double digits in the quarter and speaks to the ability of our team to drive innovation and market penetration at rates that are clearly in excess of what we see as normal market growth.

As we have said in the past, consumable usage tends to be a good indicator of market activity as it is closest to the point of use.

Given our network of service centers and store fronts as well as our parts and demand model, we continue to see growth opportunities ahead.

As we look ahead to the fourth quarter for upstream energy, we fully expect that the flattish market demand curve will continue.

But we will - we still see opportunities for growth, given existing backlog as well as continued momentum in areas like consumables.

In fact, through the first 2 weeks of October, consumables are up double digit versus the prior year.

On the mid- and downstream side, order rates were slightly down, which was in line with expectations, given the large order intake we saw in the second quarter during which orders were up collectively nearly 50%.

In addition, revenue was down 10%, again, as expected, due to the known tough comparisons from the third quarter of 2017.

This led to an overall book-to-bill ratio of 0.83 in the quarter, which is generally in line with normal second half seasonality.

Looking ahead to the fourth quarter, given the strong backlog of projects due to ship, we're fully expecting double-digit revenue growth collectively for mid- and downstream energy.

In addition, what continues to be exciting for us is the more industrial-like projects we have been winning on a global basis.

The bottom of the page highlights one such order for a multi-unit system of centrifugal blowers that was recently won for a large South America environmental remediation project, where our blowers will be integral to the oxygen aeration efforts that are mission-critical for a wastewater treatment facility.

The Energy segment delivered adjusted EBITDA of $95 million in the third quarter, down 3% excluding FX, driven almost entirely by the timing of large mid and downstream projects, which I discussed.

As percentage of revenues, third quarter adjusted EBITDA was 31.8%, down 90- basis points from prior year, also due to the previously stated timing of large downstream projects, but the margins did increase by 260- basis points sequentially versus the second quarter, with each of the underlying businesses showing positive momentum.

Moving next to the Medical segment on Slide 13, order intake continues to be very strong at $74 million, up 21% excluding FX versus the prior year.

The order performance continues to be driven by solid design wins in the core gas pump side of the business as well as increasing penetration on the liquid side of the business.

Revenues in the quarter were $71 million, up 19% excluding FX, and marking the strongest quarter of organic growth we have seen in the past 5 years, and also the second consecutive quarter of double-digit organic growth.

We continue to see strong runway in Medical, given the outsized order growth from the prior quarters and the healthy backlog we have.

And as a result, we expect double-digit revenue growth in the fourth quarter.

In terms of new products, we continue to see growing momentum on our recently launched line of liquid offerings.

Both liquid pumps and liquid handling technology are recent additions to the portfolio.

And the Medical team has been building out the innovation funnel as well as expanding the customer base to grow this margin-accretive product lines.

One such recent innovation on the liquid pump side of the business is our expanded line of liquid diaphragm pumps, which we have multiple end-use applications in such markets, such as the cleaning and disinfection of dental equipment.

Medical adjusted EBITDA was $21 million in the third quarter, which was up 23% excluding FX.

Margins were up healthy 100- basis points over prior year, due in large part of the flow-through from volume and continued operational efficiencies.

Given the expectation for double-digit growth in the fourth quarter as well as ongoing productivity initiatives, we would expect margins to continue to show expansion in the fourth quarter as compared to the last year.

Moving to Slide 15, I would like to discuss our 2018 outlook.

Given our third quarter performance and continued confidence in the ability to execute in the fourth quarter, we are reaffirming our total year 2018 adjusted EBITDA guidance range of $690 million to $705 million.

Maintaining our guidance range in this uncertain macroeconomic environment speaks to our focus on continuous improvement initiatives, both commercially and operationally in order to drive ongoing performance.

Our expectations for capital expenditures for growth and value-creation initiatives is slightly revised down to $50 million to $60 million for the year versus previously -- previous guidance and closer to 2% of revenue.

This slight downward revision should have no impact on any of our growth or operational strategies, and clearly speaks to our continued discipline on returns as well as capital allocation.

In addition, we expect the tax rate to be in the range of 26% to 28%.

And in terms of leverage, we expect net debt to be approximately 2x by year-end.

Also, we expect our average diluted shares outstanding for the balance of the year to be approximately 209 million shares, using share count and share price as of September 30.

This does not include any potential impact from future share repurchase activities.

Moving now to Slide 16, we're very pleased with our performance in the third quarter, as our team continues to execute on our strategy, while delivering strong profitable growth across the portfolio, despite macro environment noise.

We continue to remain confident in our ability to execute our initiatives, to protect our business performance and deliver our financial commitment across each of our segments.

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

(Operator Instructions) And our first question comes from Josh Pokrzywinski with Morgan Stanley.

Vicente, you gave a lot of helpful color on upstream and clearly topical in this environment.

Could you just maybe round it out a little bit further on some of that committed versus spot?

What your current mix looks like?

And when you expect to see those spot markets maybe trough out?

And I get the sense that's maybe a toggle for maybe the overall business reaccelerating.

Yes, maybe, Josh, I'll say that, as you heard from even some of the Tier 1 pressure pumper guys, they're calling out the bottom to be here in the fourth quarter.

I will say that in our perspective, we have -- the majority of our customers or a good part of our customers are in, what we call, platinum accounts.

What that allows us to do is be able to have a very kind of good look into the next couple of quarters of expectations of what they are going to do.

And that's why -- I mean, we feel that as we go into the fourth quarter, our expectation is that we're going to be reasonably consistent in terms of order rates as compared to what we saw on the last year.

Got it, that's helpful.

And then just maybe transition for the one question away from Energy on the call.

Industrial orders have been, I think, running on average up, call it mid-teens the last year.

Revenue growth has been closer to mid-singles.

And I've never thought of your business as being long cycle in Industrial necessarily.

How should we think about kind of that catch-up or narrowing of the gap between order momentum and sales momentum?

Josh, we feel that we continue to outperform the market from a perspective of being GDP plus in terms of our drivers and how we're executing ourself.

And that is driven by a lot of the activities that we're doing on new products as well as demand generation that we speak pretty highly of.

I think I'll say that what we're seeing and still continue to be in the mix is a lot of momentum on the OE.

So obviously, the new products kind of go into the market, which obviously gives us good confidence that still the cycle is, at least from our perspective, at the, what we may call it perhaps, early to medium stages.

Our next question comes from Michael Halloran with Baird.

So on the Industrials margins, obviously, nice to see some progression going into the quarter.

Todd lined out some of the headwinds going forward, particularly on the tariffs, I think, you may give some specific numbers.

But on a forward basis, could you help with some of these puts-and-takes, and how you think they impact your business?

Doesn't sound like there's any air pockets where there's misalignment between tariff or inflation pressures and pricing productivity and some of the other buckets, but maybe on a forward basis, just kind of line that out a little bit, how you're thinking about those offsets and progression towards that mid-20s EBITDA target?

Yes, Mike, we definitely continue to see that price-cost equation as being positive.

Clearly, in the third quarter we saw a full quarter of tariffs.

And some of the numbers that we indicated in terms of the impact, those are the majority of them coming through Industrials.

And even with that, in the third quarter, you saw how we were able to expand margin.

And so particularly in the quarter, what we saw is maybe the 60- basis points, we saw Runtech basically affecting that about 20- basis points.

Runtech continues to improve.

But as we said, we purchased that for the reason of expanding improving their margin.

Tariffs, you can add here another 20- basis points, and then our price and productivity and volume offsetting by 100- basis points to, therefore, giving off that net of 60 basis points.

And as we continue to see ahead, we expect that to be further similar.

Okay, that makes a lot of sense.

And then on the upstream side, you're talking about a lot of the peers or your customers thinking that fourth quarter is going to be a trough for business on that side.

Maybe you can just give some context for how you think your business is going to track over the next few quarters and the composition behind it?

You, obviously, have very strong momentum on the consumable side, particularly aftermarket and some of the initiatives there.

How does the refurb piece factor into it?

And then what are you seeing on the OE side as well?

Sure, Mike.

Maybe -- so as we perhaps look into 2019, the way we think about it, keep in mind that 80% of our business in the upstream is that aftermarket and consumables, where we made a lot of very good investments.

As I alluded on the call, expectations is that the stage count is going to continue to increase as we go into 2019, which is a good correlation to the aftermarket and the consumable.

So whether that might be stage count increase growth in that 20% and our consumable and aftermarket continues to grow at somewhat of that level, that's obviously hopefully we'll see that alignment to that.

And that kind of correlates to what we saw this year, and what we called out coming into 2018, if you remember, when we were back in 2017.

Second point that I think we see in terms of replacement OE, that 20% of the -- that we call OE, we see, obviously, more on the replacement than on the new fleet expansions.

It's too early to see the reoccurring of that OE.

But I figure that as we see good momentum because of the pipeline capacity growing in the Permian Basin, we expect that replacement OE to continue to accelerate in the second part of 2019.

And I think the third piece, Mike, that we sometimes talk about and -- but that has been muted so far is the drill pump wave.

And the estimates is that as we go into 2019, that rig count in the Lower 48 stage could be anywhere between 75 to 150 rigs higher next year potentially trending to the upper-end of that range.

And this will shape very well for not only '19 but 2020 because the driver there is that there's going to be a drive for new-build for rigs.

And obviously, that -- with our drill pump being a market leader and really strong aligned with some of the Tier 1 oil rig operators, we expect that to bode well.

And our next question comes from Andrew Kaplowitz with Citi.

Vicente, you mentioned you think you could close 1 or 2 transactions still by the end of the year.

Maybe you could talk about your appetite as you go through this deleveraging for larger deals that can begin to evolve your portfolio?

Your leverage is going to be down close to 2x.

Do you see targets out there that could help you begin to balance your portfolio away from upstream, is that even the goal?

I will say yes to that, Andy.

Of course, I think we definitely see there 1 to 2 small bolt-ons that we will do here at the end of the year.

And having said that, I mean in our -- every year when we do a strategic plan that we look ahead for the next 3 years, we definitely have a lot of potential views on how we can transform our business continuously in a much accelerated way.

And that, obviously, requires that we see an increased appetite for larger acquisitions in the Industrial and Medical side because we always said that 75% of our business is expressing the results of GDP plus, and we like that side of the business to continue to grow organically and inorganically.

So Vicente, I know you don't want to give specific guidance on '19, but it's interesting that you said you expect to see at least $400 million in free cash in '19.

It looks like that would reflect solid growth in '19 versus '18.

Maybe if you could give us a little more context on the $400 million?

Is it 100%-plus free cash flow conversion?

It looks like it also assumes solid expected EBITDA growth.

Obviously, I am trying to put words in your mouth, but if you want to give any more color there, that would be helpful.

Yes, I think you definitely hit 2 important topics there.

And also keep in mind that when we look at -- I speak about all the levers that we have still to be able to unlock cash.

And net working capital, you have seen that we have done tremendous improvement this year to go from the kind of low-30s to the mid-20s.

We definitely see the next step down to come down to maybe be in the low 20s, not saying all of it next year, but definitely continue to grow from that perspective.

And -- so we continue to see a lot of good levers.

Whether it is around net working capital, obviously, the EBITDA growth that we foresee to see in 2019 and as well continue to paying debt, which obviously reduces a lot of interest that we're paying.

And our next question comes from Joe Ritchie with Goldman Sachs.

So obviously, you guys have done a great job kind of navigating the issues in the Permian.

But if I could just ask you just a real explicit question around the next few quarters and EBITDA, so EBITDA and Energy was down this quarter, and you referenced what was going on in mid- and downstream, that seems like it's going to rectify next quarter.

But when you think about the first half in 2019, you've got tough order comps, like do you think that you can grow EBITDA in the first half of 2019?

Or should we be expecting just a little bit of weakness in the first half, and then just strength as the second half continues?

Yes, Joe, I think, the way you alluded to some of the tough comps that we might see combined maybe with some of the takeaway capacity, keep in mind, this takeaway capacity, there's some new pipes coming online in the -- or conversion of the pipelines in the second quarter.

So whether that might be a bit of an air pocket in the first quarter, but continuing strong momentum into Q2, Q3 and Q4, that's potentially maybe something that may happen.

At the same time, we're hearing from some of our customers that they're going to have a strong first quarter.

So I alluded to a bit of a bifurcated market, where we have a customer base that speaks pretty highly about what they might be seeing in the first quarter and second quarter, and then we have another set of customers that speak about maybe a delay into the second quarter and third quarter and moving on.

But I think net-net, what we still see is a very good opportunity in consumables, service and repair, and keep in mind that's 80% of our business.

So that is a driver for our business and it [needs] to continue.

Got it.

That's helpful, Vicente.

And I guess, my one follow-on question.

Just maybe a little bit more color on I2V.

Obviously, very encouraging to see you guys raise the target already.

I'm just wondering like, how much of the new additional benefit to the function of you being a little bit more focused because of some of these tariff-related issues that are out there versus the opportunities that have just come from the initial work that you've done with the initiative?

Good question, Joe.

I think interesting enough, if you remember, we talked about I2V on our -- earlier in the year on our first quarter -- actually fourth quarter call that happened earlier in the year when the tariffs noise was still not there.

So if you can think about it, we were still -- we saw this -- I mean, as I spoke many times, we continue to see this as a tremendous opportunity in our business.

I spoke about it before in the terms of value added valve engineering, or VAVE.

We put that program on steroids and made some changes.

And now we call that I2V.

And it's really reaping through the organization with tremendous benefit by not only the savings that we see but really focusing a lot on key leaders and high-potential leaders in the organization stepping up and driving some tremendous changes and momentum.

So we did it actually before we knew about all these tariffs.

So it kind of comes along as a good positive thing even for us now.

Your next question comes from Nathan Jones with Stifel.

A couple of questions about the restructuring expense that ticked up this quarter.

It's been about $25 million so far this year.

Can you talk a little bit more about what kinds of initiatives those things are going into?

What kind of benefits do you expect to see?

And when this round of restructuring and business transformation is going to be over, and we'll see that adjustment drop off there in reported results?

Yes, just a couple of quick comments, Nate.

This is Todd.

I think we have $12.3 million of restructuring and related business transformation costs, of which $5.4 million was restructuring related announced in Q3.

Most of that is general efficiency and headcount, the predominance of which was in Europe in the quarter itself.

Those tend to have 2- to 3-year paybacks in Europe, in general, which you can back into kind of the expectations for savings going forward.

As you know, our focus in the company is on continuous improvement constantly.

And so I think we've been reasonably consistent that you'll see restructuring in the business on somewhat of an ongoing basis.

Having said that, the adjustments -- and the adjusted EBITDA numbers versus prior years are shrinking, to your point.

But I don't think we'll be at a point where we'll ever have no restructuring because of our continuous improvement focus.

But it will shrink over time.

Will it just become a part of normal business costs, and you'll stop reporting it as an adjustment in these results or you'd likely -- or are you planning to keep it there?

I think we've done a little bit of benchmarking against peers and it's reasonably normal with our peer set to keep it there.

So our intention would not be to change it at the moment.

Okay.

Then I just wanted to ask another question on the drill pump business.

Nice to hear an expectation that there could be some new drill pumps going to new rigs.

There's also been an expectation of a drill pump replacement cycle.

Can you talk about what kind of discussions you're having with customers?

What's the timing of that is in your expectation?

Nathan, I'll take that.

I mean, as a matter of fact, as we speak right now today, our team is in Quincy, Illinois, with 2 large customers kind of reviewing a lot of our pump design against other manufacturing designs and doing some benchmarking and things like that.

So that tells you of the ongoing communication that we're having and kind of the live activity.

Now I think -- so there will be some wave, kind of difficult to know when that replacement of drill pump wave will come, but we're definitely having a lot of proactive communication with a lot of customers that we did not have in the past that as they go in to replacing those pumps, we want them to be replacing with our pumps.

Your next question comes from Bill Herbert with Simmons.

Vincente, can you talk about pricing with regard to consumable?

Sounds like it's pretty resilient, but are you seeing any pressure at all on that front with regard to energy consumables, upstream energy?

No, Bill.

Energy consumables continues to be very resilient.

And keep in mind that we'll keep launching innovation.

Our packing line being kind of lasting 2x anywhere of the other competitors and things like that.

We can definitely command a higher ASP.

Okay.

And then with regard to just the forward path, we've covered this, but I want to get a little bit more granular about this and also reset some assumptions.

In the event that completions activity in 2019 is really bifurcated and probably more subdued than the up 20% than what you possibly indicated, I realize that's not a forecast, that's a possibility, but in the event first half 2019 continues to stagnate, we get incremental improvement in the second half, but the rate of improvement is yet to be seen, so the components of that will be OE probably down year-over-year, consumables probably continues to hang in there due to service intensity, and then downstream and midstream up, so does that yield overall growth for Energy top line in 2019?

So I'll say, maybe to the points, so consumables, as you said, hang in there and maybe continue to see some growth primarily because of how we have launched the innovation and seen the acceleration of the consumable line this year.

So we'll definitely be able to see continued growth even in this first half, we believe, even with subdued or flattening of the demand, if that's going to be the case.

And on the OE, as you know, Bill, we have -- that 20% is split kind of 50-50 between new pumps and replacement pumps.

So that's going to be -- we'll definitely see a tougher comp on half of that 20%, which is basically the new pumps because we don't foresee a lot of new fleet expansion going on in 2019.

However, with the level of intensity that we may see in 2019, due to the kind of well-known capacity upticks, we may expect that potentially the replacement of the pumps to be much higher.

So kind of the blend to be instead of 50:50, more like 70:30 or even 80:20 more on the replacement than the OE.

Okay, got it.

And then Todd, with regard to capital spending, is 2% a decent baseline, 2% of sales, is that a decent baseline assumption for 2019 at this stage?

Yes.

You've seen us go 2% to 3% over the last several years.

And 2% is probably on the efficient side.

And we give ourselves a little bit of buffer room up, if we see major projects with major returns that might be worth investing in.

But I think you're thinking about it the right way.

Your next question comes from Julian Mitchell with Barclays.

Just circling back to your EBITDA guidance, it's the second quarter in a row you've kept a high-end.

That high-end implies a high-teens increase or $30 million sequentially in Q4 from Q3.

That looks pretty high versus history, particularly as the corporate costs look light in Q3.

So maybe you could help us understand how that extra $30 million of EBITDA splits out across the segments?

Yes.

I mean maybe just a quick overall, Julian, on that, first.

I'll say that we expect definitely to be in that range of the guidance we provided.

As we stated, we see market conditions to remain -- they still remain pretty healthy across all the end-market that we're playing.

And so we can see that mid- and downstream has a good fourth quarter.

We expect mid- and downstream to be up in the kind of 20% to 25% in terms of year-over-year revenue growth.

We continue to see Industrials to be in the high single-digit growth and the Medical will continue to be in that kind of mid-teens growth momentum -- mid-teens to upper teens momentum of growth.

So when you put all these pieces into question, you can see that -- not kind of -- what I call maybe the swing factor could be the upstream side.

And the upstream side, we see that there -- even though there is some flattening of the demand, that we still see continued year-over-year growth momentum in the fourth quarter.

But you can see that the upstream kind of is coupled with a couple of factors, you got weather and potential extended holidays from our customers that could result in the low side of the range.

But obviously, if everything continues and our customers continue to accelerate getting ready, then that could be on the higher side of the -- of kind of mid-range of the guidance that we provided.

Very helpful.

And then just, Vicente, you mentioned upstream energy at the end there.

So just circling back on that, help us understand maybe the orders cadence.

Orders are up almost 30% for most of the first month of the quarter, they were up 9% for the quarter as a whole.

So presumably September had a big drop in common with your industry peers year-on-year.

So if you could just discuss that?

And also the extent to which your view differs from Schlumberger.

I think, Schlumberger had talked about many of their North America operators laying down their frac fleets over November through January.

It doesn't sound like you agree with that perspective.

So maybe just help us understand the difference of their exposure versus yours?

Yes, Julian, I think, within the quarter, one of the data points that we always like to talk about and speak of is consumables because that's kind of the last what we may say it's spotty, in the sense that as long as activity kind of continues, these consumables, they get replaced on a weekly or even potentially daily basis in some cases.

And if I look at the run-rate that we saw in the third quarter, it was actually fairly consistent from an order rate perspective throughout the quarter.

Now you could see some spottiness or maybe bumps, which it could be in tune in terms of when they get older or when they get replaced, and there's also going to be a bit of spottiness on that side.

But that's why we always like to talk about the consumables in the more tune just based -- because we think that's a good, better indicator of the activity.

To the comment of Schlumberger, it's kind of what I alluded to that we see this bifurcation of the market that some customers that are still seeing some momentum.

Now as I just mentioned here, it could be weather, it could be a lot of extended holidays.

I think, in this case, maybe you mentioned that Schlumberger might have mentioned that.

I know they're a Tier 1 public company, talked about Q4 to be a really great quarter to do a lot of maintenance and service.

And that's basically what drives our business.

So I think what we see is that many customers, as they might be parking their fleets or taking extended time, they might be using that time to kind of shiny up and get their fleets up and running for the Q1 and also first half of 2019.

Your next question comes from Brian Drab with William Blair.

I'm going to see if I could press you to give us a little more specific data points to enter into the model here and I'll see what you say, but on Medical, it's a nice step function increase in revenue.

And just in terms of dollars, is there anything to call out in the third quarter?

Is there any reason why you wouldn't be able to sustain that level of revenue in terms of dollars going into the fourth quarter and maybe as we enter 2019?

Because if you did sustain that level of dollars, you'd get 20%-plus growth in the fourth quarter.

Yes.

Brian, one of the things is that typically what Medical sees in the fourth quarter is a bit of seasonality coming down.

It's just historically based on how the customers, a lot of OEM customers, they kind of manage their inventory sort of speak to the end of the year.

So that's the only reason why you don't see that sequential uptick.

Okay, got it.

And then in terms of just EBITDA margin for the segments, could you go through the segments and tell us whatever you're willing to in terms of what you expect sequentially from third to fourth quarter?

On the last call, I believe you mentioned for Energy that 34-ish was a reasonable estimate.

What's the current thinking?

Current thinking, we see Industrials in the kind of 23, low 23-ish.

Energy -- let me go Medical, Medical in the same as what we did in the third quarter.

And Energy consistent to the third quarter, a bit of difference in the sense of how we talked about the 34 versus the 32-ish, so to speak now, is just as we saw going from Q3, there were some large orders in the midstream that got pushed into Q4.

And those orders, kind of project-based, in the midstream are at a lower blended average EBITDA than what we see in the segment.

And that's really what's driving kind of the difference in the rate.

And you said for Medical similar to the third quarter?

Yes.

And our next question comes from Damian Karas with UBS.

So I think you've done quite a good job of laying out what you're seeing and what your expectations are in terms of growth in the upstream energy.

But I wanted to ask you about the other side of the business.

You talked about the good backlog you have heading into '19.

Could you maybe give us some color around the composition of that backlog?

Maybe any details you could provide around geographic or product concentration as well as the lead times there?

Yes.

So the product concentration is really more on the downstream side than the midstream.

And when you think about the concentration of the end-markets is really -- it's very broad, Damian.

I think we have seen a lot of these kind of good process flow orders, and particularly -- I mean, the one that we just talked about here in the earnings call is one that will definitely get into the next year, and that's the wastewater treatment application.

We also see some good backlog around what we call the chemical industrial processing side of things, that basically take into account either our rough vacuums that we have on the NASH business, but also our liquid compression on the GARO side.

So basically more on the downstream side, really process-driven industries.

And we still see good momentum from kind of quotation side.

Okay.

Any changes in the larger -- kind of the larger or longer cycle project funnel since last quarter?

No, not really.

No change.

Okay.

And then just thinking about the Energy segment margins overall, this past quarter saw a little bit of a decline versus last year, but you're still operating it at quite high levels there.

Could you maybe just talk about thinking about 2019, potential headwinds, tailwinds for the segment kind of as it relates to cost inflation, price, productivity, mix, kind of anything else that you're thinking about for the segment margins into '19?

I think, Damian, the way we look at it is that, as we have been able to do a lot of this price cost inflation, we wanted to be positive, and we're driving a lot of initiatives to ensure that we stay on the positive side.

So I believe that the Energy segment will continue to see momentum in 2019 from a margin expansion basis.

On a quarter-to-quarter, it could vary based on just a mix of projects.

As you know, second half tends to be a higher-margin expansion from a perspective of the timing of the projects when the downstream ships.

I think you saw here in the third quarter pretty tough comps.

I mean, last year, we shipped a lot of our downstream in the third quarter in 2017 versus what we have done here in the third quarter.

And this will conclude our question-and-answer session.

I would like to turn the call back to Vicente Reynal for any closing remarks.

Well, thank you, everyone, for the continued interest on Gardner Denver.

As you can see, we tried to be very transparent with our financials and with our information, and as we want to continue to help the investor community understand our business.

I want to also thank all of our Gardner Denver employees for the fantastic work that they have done in the third quarter, and moving on towards here in the fourth quarter to finish strong in 2018.

So thank you, again.

The conference has now concluded.

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