格南登福 (IR) 2019 Q2 法說會逐字稿

Good day, and welcome to the Gardner Denver Second Quarter 2019 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 2019 Second Quarter Earnings Call.

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

And with me today are Vicente Reynal, Chief Executive Officer; and Neil Snyder, Chief Financial Officer.

Our earnings release, which was issued yesterday and a supplemental presentation, which we reference 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, we will review our second quarter highlights and 2019 guidance as well as an update on the pending transaction with Ingersoll Rand.

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.

Turning to Slide 5, let me start with a brief overview of the second quarter.

Overall, Q2 was a solid quarter with strong operational execution across the businesses.

Despite continued noise on the macroeconomic front in our upstream Energy business, we delivered revenue, adjusted EBITDA and earnings per share that were largely in line with our expectations.

And I'm very pleased with the efforts that the teams are taking across the company to drive operational efficiency and control cost.

Our businesses that we have identified as being GDP-driven collectively saw positive revenue growth of 4%, excluding FX, and triple-digit adjusted EBITDA margin expansion.

Let me provide a bit more color on the financial highlights in the second quarter.

From a total company perspective, revenue and adjusted EBITDA results were impacted by upstream Energy.

Despite this impact, we were able to achieve adjusted EBITDA of $148 million and overall margin of 23.5%.

The upstream energy market continues to be challenged, driven mainly by supply and demand imbalances and limited market visibility.

Despite the headwinds in upstream Energy, I continue to be pleased with the performance across the balance of portfolio as our GDP-exposed businesses of Industrials, Medical and mid and downstream Energy collectively grew revenue above GDP.

In addition, we continue to see solid momentum on operational initiatives like Innovate 2 Value and targeted restructuring to offset known headwinds, such as tariffs.

As I mentioned earlier, both the Industrials and Medical segments saw triple-digit adjusted EBITDA margin expansion for the third consecutive quarter.

And we continue to see runway for healthy margin expansion in these businesses in the second half of the year.

From a balance sheet and cash perspective, free cash flow in the quarter was $51 million.

Free cash flow conversion to reported net income was 113% as the teams continue to remain disciplined on capital allocation and managing working capital.

Net debt leverage remain at 2x at quarter end.

The combination of our strong balance sheet, capacity on our recent expanded revolver and free cash flow provides us current liquidity in excess of $800 million to support ongoing capital deployment priorities.

One exciting example of this was the recent announcement of our medical acquisition, Oina, which is a Swedish-based company offering customized solutions for liquid and gas handling, including peristaltic pumps, piston pumps and diaphragm pumps.

We view this technology as highly complementary to both our Medical segment strategy as well as complementary to the fluid management portfolio that is part of the Ingersoll Rand Industrial segment.

Turning to Slide 6. I would like to spend a few minutes providing an update on the pending transaction with Ingersoll Rand's Industrial segment.

As we outlined in our transaction call at the end of April, combining Gardner Denver and Ingersoll Rand's Industrial segment brings together 2 companies with long histories of innovation, premium brands, talented employees, and more important, winning cultures to create a diversified global leader in mission-critical flow creation and industrial technologies.

As I have gotten to know the Ingersoll Rand team better over the last few months, I'm even more confident today in our ability to create a premier industrial leader and deliver ongoing value creation to our shareholders.

Moving to a quick update on the transaction, I am pleased to report that we have moved past the first major step in the regulatory approval process, as the June 29 waiting period for U.S. antitrust clearance expired with no further inquiries.

In addition, the international antitrust process is currently underway and progressing as expected.

While there are more steps to clear in the regulatory process and the separation of the Ingersoll Rand Industrial business, we remain comfortable that the deal is on track to close by early 2020.

The teams from both Gardner Denver and Ingersoll Rand's Industrial segment are also making good progress in terms of joint integration planning.

I'll provide an overview on how the integration is being managed on the following page.

But based on the work we have done so far, we continue to remain confident in our ability to achieve the $250 million of cost synergy target by the end of year 3 after the close of this deal.

I also had the opportunity a few weeks ago to host a town hall meeting at Ingersoll Rand headquarters in North Carolina with the global Industrial team.

It was great to see the strong culture of engagement that the entire team has and the commitment to providing high-quality products and superior customer service that I know were also shared here at Gardner Denver.

Moving to Slide 7. As you know from the many commercial and operational initiatives we have implemented at Gardner Denver over the past few years, I am a firm believer that a strong process and a structured cadence for execution managed within the business is key to success.

As a result, we're using the principles of the Gardner Denver Execution Excellence process or GDX to manage the integration planning and later on, the execution of integration.

We have used the GDX process and the toolkit of Growth Rooms and standard work to integrate many of the bolt-on acquisitions we have done over the past few years.

This has led to a more thorough and timely integration and the ability to achieve financial criteria on or ahead of schedule and in certain instances, in excess of expectations.

We're taking the same approach and now applying it to the Ingersoll Rand transaction.

The process is based on strong engagement from a cross-functional team of leaders from both businesses.

Today, we have over 150 employees from both Gardner Denver and Ingersoll Rand engaged in the integration planning, and they are structured across 23 different work streams to ensure full coverage of the business.

Each work stream followed a very simple but structured process of building charters, blueprints and work plans to clearly define current state value-stream mapping to then create optimized future state.

The end result is a functional game plan on how to operate as a new company as well as plans for delivering synergies across the enterprise beginning on day 1.

While we're only about 2 months into our integration planning efforts, I am very pleased with the progress we're making, as I am personally participating in weekly Growth Rooms and integration update calls and can see the high level of engagement, the energy and the progress across both teams.

Turning to Slide 8. Our commitment to our strategy remains unchanged.

We recently completed our annual engagement survey across the entire business.

And we set another record on engagement scores with over 300 basis points of improvement since 2017.

We continue to see that a high degree of employee engagement, coupled with an ownership mentality, is a key catalyst for current and future profitable growth.

Moving to Slide 9, I will provide more color on the operating performance of our segments.

I will start with the Industrials segment, where we continue to see solid momentum on both commercial and operational initiatives.

The Industrial segment second quarter order intake was $323 million, which was flat to prior year, excluding FX.

Revenues in the quarter were $334 million, up 5%, excluding FX.

I am pleased that our 2 largest geographic regions, the Americas and Europe, saw positive FX-adjusted orders growth despite continued market concerns around the softening macroeconomic backdrop.

We did see negative orders performance in Asia Pacific, but that was due to a large Runtech order placed in the prior year.

However, in-year demand for Runtech turbo blower technology remains relatively healthy and the business remains on pace for solid year-over-year growth.

In terms of the product lines, we continue to see solid performance in core oil lubricated compressors and blowers, which were both up mid- to high-single digits.

We're also very pleased with the continued performance of our oil-free compressor portfolio, as we continue to see double-digit growth year-over-year.

On the other hand, vacuum continued to see some softening, particularly in Western European markets and China, as our business is more aligned with industrial process-oriented OEMs, where we have seen a decline mainly due to global trade tensions and uncertainty.

Feedback from our Western European customers is changing to more positive as they see some pent-up demand later in 2019 and early 2020.

In general, we continue to see stable demand for niche products, with particular momentum in areas like high-pressure and transport equipment as well as our portfolio of oil-free offerings beyond the compressor product line as we expand the technology into new segments.

One such product is our new oil-free claw vacuum pump, highlighted on the bottom of the slide.

This vacuum pump provides oil-free air and the benefits of higher efficiency, smaller footprint and reduced noise for demanding applications, such as food packaging and processing.

From a regional perspective, the Americas continued to be the strongest region, with mid-single digit growth in orders and healthy double-digit growth in revenue in the quarter.

Europe continues to be relatively stable, excluding FX, with low-single-digit order growth and slightly negative revenue growth.

We did see a slowdown in Germany with offsets from stronger performance in countries like U.K. and France.

In Asia Pacific, we continued to see mixed performance in China, with declines in oil lubricated compressor offset by growth in niche products like blowers.

What is very encouraging is that both orders and revenue performance improved sequentially in Asia Pacific from Q1 to Q2.

And we continue to monitor the market closely given ongoing uncertainty around trade tensions and tariffs.

Moving to adjusted EBITDA, Industrials delivered $77 million in the quarter, up 12%, excluding FX.

Second quarter adjusted EBITDA margin was 22.9%, up 130 basis points versus prior year.

The year-over-year margin increase was achieved despite ongoing headwinds such as tariffs, which were approximately $2 million of incremental cost in the quarter for total Gardner Denver, the majority of which impacted the Industrials business.

This speaks to the benefits we're seeing from initiatives like pricing, aftermarket growth and Innovate 2 Value, all of which we expect to continue to contribute to ongoing margin expansion in the second half of the year.

Moving next to the Energy segment on Slide 10.

The Energy second quarter order intake was $207 million, down 30%, excluding FX, driven by the downturn in upstream Energy and the timing of larger project order in the mid- and downstream businesses taken in the prior year.

Revenues in the quarter were $223 million, down 17%, excluding FX, with upstream revenues down 26% and mid- and downstream revenues collectively down 3%, excluding FX.

Addressing the components of Energy, let me first start with upstream.

Orders were down 35% and revenue was down 26%, both excluding FX, as the market downturn drove results below our original expectations.

In general, the market is largely book-and-ship oriented with minimal original equipment orders and nearly all activity is driven by aftermarket parts and services.

Unlike prior quarters, where we have typically experienced end of quarter momentum with orders ramping up, Q2 was relatively stable from April to June, with most oilfield service companies pushing out or deferring purchases when possible.

While we originally expected to face short-term headwinds in the first half of the year, we now see market stagnating continuing for the remainder of the year.

Longer-term factors continue to be positive, such as the DUC count remaining above 8,200 wells and the Permian Basin continuing to see an overall trend in DUC count increasing.

In addition, the incremental pipeline capacity coming on board, all of those are all positive signs of medium- to long-term recovery likely at some point in time in 2020.

However, from a shorter-term perspective, the market remains very opaque, as customer conversations indicate very limited visibility for the second half of the year.

With capacity utilization under 67%, and close to the lowest level in the past 8 quarters, plus E&Ps controlling cash flows and oilfield services customers demonstrating more discipline on a quarter-to-quarter basis, we expect second half order rates to look comparable to what we experienced in the second quarter.

Having said this, we believe we continue to gain share of wallet through innovation, breadth of product portfolio, particularly aftermarket and consumables, and our best-in-class service and repair footprint.

To best put this into perspective, many of you recall that in 2017, when market conditions were accelerating, we called out a fairly consistent $150 million of orders per quarter or a $50 million per month run rate.

Keep in mind that back then, this included pent-up demand as fleets were getting reinstated as well as a lot of retraining for OFS field service techs that created a higher run rate of repairs and services.

And now, even with the slowdown, what we see is a more normalized order rate of approximately $30 million per month or approximately $100 million per quarter of mostly aftermarket revenue.

While the upstream market may be currently seeing a downturn, I am encouraged by the steps the teams are making to continue to bring longer-lasting, customer-centric innovation to the market.

I'm excited to announce the Thunder E-Max frac pump, which you can see highlighted at the bottom of the page.

The Thunder E-Max builds upon the long stroke and longer-lasting nature of the original and proven technology from Thunder series pump, with an enhanced design that is capable of delivering up to 5,000 horsepower.

The pump is particularly well suited to the emerging concept of electric frac or e-frac, which typically looks for higher horsepower pumps with increased efficiency.

The combination of this pump technology that includes our next generation of fluid ends, which can last up to 10 months in the field, creates a unique value proposition for customers looking to enter e-frac with a proven technology and best-in-class maintenance cost.

The Gardner Denver team has consistently proven its ability to launch innovative products that provide ongoing benefits to the customer.

And the Thunder E-Max should be no different as it comes to the market in the second half of the year.

On the mid and downstream side, revenue was collectively down 3%, and orders were down double-digit, both excluding FX.

After strong double-digit revenue growth in the first quarter, including 2 larger project shipments in the midstream business, we expected revenue to be slightly down in the quarter.

Importantly, revenue for the first half of the year is up 11% excluding FX, with positive growth from both the mid and downstream businesses, again, demonstrating that this side of the Energy segment continues to demonstrate performance well in excess of GDP.

On the orders side, the second quarter of 2018 was an extremely challenging comp as we saw growth of over 40% last year and a large concentration of project orders booked within the quarter.

What continues to give us confidence here is that book-to-bill remain above 1. In addition, in the second quarter, we saw a continued increase in project funnel, but with customers continuing to place delays on releasing the orders.

We feel there is going to be some pent-up demand in the latter half of the year and into early 2020 based on the activity we see in the field.

The Energy segment delivered adjusted EBITDA of $56 million in the second quarter, which was down 28% to prior year excluding FX.

As a percentage of revenue, second quarter adjusted EBITDA was 25.3%, down 390 basis points from prior year due almost entirely to upstream Energy.

Upstream Energy margins still remain above total Energy segment margins, and we continue to take prudent cost actions in the business to restructure and right-size in line with market conditions.

Moving next to the Medical segment on Slide 11.

Order intake was solid at $76 million, up 9% excluding FX.

Revenues in the quarter were $72 million, up 12% excluding FX.

This marked the fifth consecutive quarter of double-digit organic growth as the business continues to execute well on innovation and prior design wins.

In addition, this puts book-to-bill at 1.06 as the team continues to build profitable backlog for the second half of the year.

As we have discussed over the past year, building out a more robust M&A funnel in the Medical segment and looking for ways to inorganically accelerate the growth momentum on the segment have been high priorities.

I'm excited by the addition of Oina, which we announced in July.

Oina is the manufacturer of peristaltic pumps, which are used in high precision liquid handling applications.

Peristaltic technology has been a gap in our existing product portfolio.

With the combination of Oina's innovative product, along with the Medical segment's operational footprint and commercial reach, we have high expectations for profitable growth as we integrate Oina into the business.

Medical adjusted EBITDA performance for the quarter was $21 million, up 23% excluding FX.

Margins were 29.7%, up 260 basis points versus prior year and can be attributed to strong flow-through from volume increases and continued operational efficiencies in the plant.

Turning to Slide 12 on guidance.

We are revising total year guidance for adjusted EBITDA to a range of $610 million to $630 million from $680 million to $710 million.

This revision is directly attributable to our upstream business and includes an expected revenue decrease of approximately 30% on a total year basis for upstream Energy.

Please note that the outlook for the remainder of our business, Industrials, Medical and mid and downstream Energy, remains unchanged, with mid-single digit revenue growth before the impact of FX.

The impact of M&A is mainly in the Industrials segment and Industrials' mid-single-digit revenue growth could be characterized as 40% organic and 60% M&A.

Also, we're expecting year-end net debt leverage to be between a range of 1.8x and 2x, largely attributed to the reduction in adjusted EBITDA.

In addition, we expect a slight improvement in the tax rate with a range of 22% to 24%, driven largely by geographic profit mix.

From a cash flow perspective, we continue to target greater than 100% free cash flow to net income conversion.

And while our CapEx range remains between $50 million and $60 million, we will continue to be prudent and focus on high-return investments.

Overall, while short-term upstream energy market concerns weighed on the overall company outlook, I am pleased with the performance in our GDP-exposed businesses.

As we continue to progress towards the Q1 2020 closure of the pending Ingersoll Rand transaction, the long-term prospects of the combined company look very positive.

And I am very encouraged by the integration planning thus far and confident in the team's ability to identify and execute meaningful areas of value creation for our shareholders post close.

So with that, I'll turn the call over to the operator and open it for Q&A.

(Operator Instructions) Our first question comes from Nathan Jones of Stifel.

I'm actually going to start off in Industrial, which I'm sure is a little surprising.

Growth there was actually pretty good.

It looks like about 2% organic growth in the Industrial business.

Certainly, you've got a lot of revenue coming from Europe and China that have had a lot of macro uncertainty and upheaval over the last few quarters.

Maybe you can talk about some of the underlying markets there?

I know you're a little more nichey than the overall industrial economy.

And what you think the contribution you're getting from market share gains related to new product releases and such is?

Yes.

Thanks, Nathan.

So as you said, we're very pleased with the momentum that the team is driving organically, I mean, roughly 2.5%.

I mean so you're pretty close on that organic growth momentum.

The Americas, as we've said, up mid-single digits in orders, double-digit in revenue for the quarter.

We continue to be very pleased in Europe with orders in the low-single digit.

And yes, I mean, some of the share gains is really primarily or some of the good momentum is really primarily by the initiatives that we have around innovation.

So we continue to launch innovative products.

You saw that we're expanding our oil-free technology.

In this case, taking some of the learnings from oil-free compressors and applying that to oil-free vacuum applications with the claw technology that we just launched, that so far tremendous or some very good feedback from the market.

And as you pointed out, the niche segments continue to do really well, where we continue to see double-digit orders and revenue growth on this kind of niche applications.

And the exciting thing here is that the team continues to identify more niche end markets, and we continue to do a lot of voice of the customer to really accelerate the penetration.

China is relatively small, but very good in areas like blowers, and an area that we continue to see some pretty good momentum.

But I mean China, the opportunity there exists in the sense that we have such a very low market share that we're just getting ready and prepared for when things kind of get better economically in China and be ready to take more share.

Maybe you could talk a little bit about your ability to sustain this even kind of low-single-digit growth, which I actually think is pretty good performance in this kind of environment.

The macro doesn't seem to be getting a whole lot better.

I know maybe you're coming up on lapping some of these new product releases, lapping some of these market share gains.

Is there a significant amount of new product in the pipeline, new markets that you're attacking now where you think you can sustain this kind of low-single-digit growth in this kind of macro environment and continue to outperform the underlying markets?

Yes.

Well, Nathan -- and the comment about lapping some tough comps, it is spot on.

I mean if you remember Q2 of last year, orders were up something like 14% and revenue up 12%.

So even with that lapping of double-digit strong momentum, we're still generating some good solid momentum.

And I think I attribute that to the initiatives that we have spoken about.

Number one, demand generation continues to show and demonstrate how we reach and educate customers, which is a largely fragmented customer base because of all the diverse end markets.

And demand generation is providing us a lot of analytics and statistics for us to be more precise to kind of unique niche markets or end markets or even subregions within the region on how we target and blanket specific markets with technologies.

And the second piece of that is innovation.

We're a true believer that differentiation in the market across all of our segments, whether Industrials, Medical and Energy, it's all around innovation and it's been proven that when we launch a new product, customers listen and they react.

So yes, I mean, we continue to target above GDP growth, and that's what the -- the initiatives that have in place is -- and the execution of the team and the execution through these Growth Rooms, it gives -- or the GDX, is what gives us the confidence to continue performing like this.

Our next question comes from Mike Halloran of Baird.

So sticking kind of on the Industrials side and in the context of guidance, is the underlying assumption from here relative stability within your core industrial markets from 2Q kind of run rate?

And is the confidence in maintaining the overall growth rate partially due to comparisons, what you're seeing in the order book?

Maybe just give some color on why the confidence in that rate and maybe marry those 2 pieces?

Yes.

Sure, Mike.

So the second half is consistent with the second quarter, and I categorize that in a couple buckets.

First, half of the growth in Q3 and Q4 is coming from M&A, where MP Pumps and DV are doing very well.

The second piece is the organic, which we view as consistent in Q3 due to the price that we have done as well as ongoing focus on niche segments and some of the demand generation and innovation, which continues to do actually quite nicely.

And the third is, in the fourth quarter, we expect some acceleration from the third quarter coming from normal seasonality plus we have some large custom engineering order projects that are already in the backlog, kind of similar to what we do in downstream, it's just in this case, is more into the Industrials segment, particularly in Asia, in Korea, that is expected to ship in December.

And then kind of a broader question, probably more associated with Industrial than your mid and downstream assets.

But maybe you could just talk a little bit about the differences you're seeing in kind of your shorter-cycle-oriented Industrial assets versus maybe the project environment.

And then layer on top of that, what the customer thought process is right now, what kind of delays you're seeing in the marketplace?

How does the funnel look versus what conversion looks like and whether or not there's just a lot of uncertainty that's driving delayed decisions?

Yes.

So I guess we can't characterize this, and we kind of consider some of these compressor more of -- you could argue it's short cycle, right?

I mean our dealers are not stocking any of these products.

And this is just basically same thing with the blowers.

So we continue to see solid performance in core oil lubricated compressors and blowers, both are mid-single digit to high-single digit.

Also, oil-free compressors, which I also -- even though we kind of view those as we -- when we book it, we typically ship it within the same quarter, and we see those as well in a double-digit growth environment.

From a large project perspective, the way I categorize this is that we're very encouraged by the funnel growth that we are seeing from our commercial teams.

What obviously we don't like is that customer decision is taking longer.

It's not that -- a lot of our data says that it is not that we're losing the orders, it's just customers are holding onto those larger-ticket item decision-making.

Now this is in some regards kind of what we think might be some -- potentially bringing some pent-up demand here, maybe in terms of orders here in the later part of the year or in early 2020.

So these are projects that our customers are telling us are going to happen, they're just not releasing the CapEx funds.

Our next question comes from Julian Mitchell of Barclays.

Maybe just the first question around the free cash flow.

That was down, I think, 60% in Q2 and down 40% in the first half.

What are you expecting for the full year now?

I think it was $400 million.

Should we think closer to $300 million, and so a sort of flattish year-on-year in the second half?

Yes.

Julian, we did expect free cash flow for the year to be roughly $400 million.

But now we still see 100% cash conversion, but we do expect approximately $300 million for the year.

And the result is really attributed to 2 factors: one, the lower full year EBITDA guidance; and two, approximately $50 million to $60 million of cash outflow this year related to the Ingersoll Rand transaction, as we're working to accelerate the separation and the integration planning activities.

And then just following up on that, that cash conversion is against the GAAP net income, right?

Against adjusted net income, it's running well below $100 million, I think?

Yes.

On prior quarters, we used free cash flow to adjusted net income.

In this quarter and going forward, we've moved to free cash flow to reported or GAAP net income.

And kind of why did we do the move?

One, the metric's more conventional and more importantly, we think it's more reflective of our cash conversion going forward in light of more significant onetime cash outflows that will be related to the IR separation, integration and synergy realization over the next few years.

And then just second topic on Energy.

Looks like you're assuming Energy EBITDA is down maybe about 30% through the second half of the year, or 30%, 35%.

Just wanted to check that's about right and if there is any split over that, that Q3 versus Q4 should look different?

Yes.

Nathan (sic) [Julian], so for the second half, it's roughly about right.

Kind of what we see, obviously, slightly more pronounced in the third quarter.

If I look at it from a basis point perspective, think about it around 350 basis points in the third quarter and about 50 basis points in the fourth quarter.

Again, this is driven by the fact that there is a lot of downstream projects that will tend to get shipped here in the fourth quarter.

Our next question comes from Joshua Pokrzywinski of Morgan Stanley.

Neil, can I just follow up on something you said earlier on the free cash conversion?

So in the guidance page, that 100% for both columns, is that 100% apples-to-oranges?

And what would that look like kind of prior on a GAAP basis, if that's what we're going with going forward?

On a GAAP basis going forward, it's going to be above 100%.

And historically, we would have run well above.

If you remember, there was a lot of noise in our historical reported net income coming out of the take-private period.

So now that we've got more normalized reported net income, we see a clear path to greater than a 100% conversion.

Yes.

I guess I'm just looking at the 2 columns where you're at 100% on both, but if the convention is changing, it's a little harder to compare.

So was that 120% before on reported and now you think it's 100%?

Just trying to calibrate the change relative to the April guidance more than anything else.

Yes.

I think it's more 400 to 300.

And I think on the reported -- yes, I mean, it would have been about 100% on the reported and may be slightly higher on an adjusted.

Okay.

Got it.

And then the decrementals on the upstream Energy business at about 55%, Vicente, not unreasonable given where this business has been historically and some of the operating leverage it's had and certainly where it's been on the upside.

But can you talk about what those cost mitigation actions were?

So what are the real savings?

And then as this business stabilizes, is 55% the right percentage on the upside?

Or is that just an exacerbated number right now because the volume drop has been so steep?

Yes.

No, exactly, Josh.

I think it's being exacerbated because of the volume drop.

But think about it incremental and decremental, they tend to be in the 40% range and can be definitely somewhat dependent on product mix.

I think particularly what we saw here on a higher decremental is some price erosion on fluid ends, particularly on the upstream side.

But obviously, the team has taken some action in terms of restructuring.

So kind of net-net, that's some of the things that we see here.

I think the main point to continue to think about is that, particularly on the upstream side, again, when you look at the revenue decrease on the Energy side, it really came from the upstream.

And just to keep in mind, I mean, even with this decremental, still the first half of 2019 are still generating 29% EBITDA margins in this business.

Our next question comes from Andrew Kaplowitz of Citi.

Vicente, we know within upstream Energy, you have several large customers that usually have long-term relatively steady contracts with you.

Obviously, these customers have lowered their spending plans, but given your change in upstream guidance, did your customers just abruptly change their plans?

I mean could you talk about your confidence that these customers won't further lower their spend moving forward?

Yes.

Andy, so I think what we saw in the month of June, it was very different from any other pattern that we had seen in prior quarters.

And that's what that -- we took the decision to take a very prudent view here in the second half and assume that customers, based on that what we saw and based on conversations, that they're telling us that the market has too much capacity, utilization rates are at a multi-quarter low, fleets are getting stacked and so on, so on, that we decided to take a very prudent view for the second half, adjust the business, adjust the cost bases of the business and drive the business forward at these kind of new levels that we see.

And obviously, if things materialize and pick up from here on, we'll be definitely ready from that.

I think the other thing that is very encouraging to us is that we have spoken in the past about drill pumps and how there has been conversations.

And we have now some very active funnel for drill pumps that we're looking positive to maybe freeing up here in the second half.

Again, we did not include that in our guidance here because it's always one of those that could tend to get delayed.

But if it comes and gives us a greater clarity, it will be a good outcome and especially, the level of confidence on drill pumps here is mainly because it comes in from an international market, where there's been some good solid momentum across different OFS companies or different drill companies in the international markets, more so than the U.S. market.

That is interesting, regarding the drill pumps.

Look, if I could just shift to Industrial for a second again.

One initiative you guys have had is just really trying to beef up your aftermarket presence.

So when you look at Industrial OE versus aftermarket, has the aftermarket growth changed at all?

And how much ability do you have to push on aftermarket growth if OE demand weakness exacerbates a bit?

Yes.

No, Andy, great question.

If you remember, last year, we talked a lot about seeding the market with a lot of the new products and OE.

And now here is when we're starting to see the pickup of the aftermarket of that kind of seeding that we did in the market.

So yes, when you look at the second quarter, we saw slightly better momentum here in the aftermarket, particularly because of the increase of the OE products that we have put in the market, but also because of the execution that we're driving with the teams, with the GDX tools in the sense of aftermarket is one of the Growth Rooms that we drive, and it's proven to drive some pretty good momentum.

I mean I can tell you in Europe, the team in Europe have seen some resurgence in the aftermarket, particularly around this.

And the other point is our iConn.

Our iConn platform continues to get better penetration, iConn, the IoT platform that we have.

And as you remember, we have now 2 Board members that are very specialized on this technology.

And the amount of incremental value that our Board members are giving us strategically and tactically has been great.

So we're pretty -- we're looking forward to continuing our kind of connectivity of this platform to accelerate the aftermarket.

Is the percent of aftermarket about 40% now, Vicente, or...?

No.

It continues to still be in that kind of mid to mid 30s -- mid to high 30s, yes, for Industrials.

Our next question comes from Joe Ritchie of Goldman Sachs.

Just a couple clarifications.

Sorry to harp on the change in the free cash flow convention, but obviously, the absolute number is a pretty big difference between your GAAP net income and your adjusted net income.

And so Neil, you mentioned earlier, I think, roughly $50 million in cost associated with some integration of the Ingersoll Rand assets.

I'm just trying to understand, like what else is part of the delta?

And then how should we think about that structurally beyond this year?

Yes.

Roughly half the decline would be a reduction in the EBITDA guidance.

And the other half of the reduction would be attributable, as you mentioned, to the Ingersoll Rand activities that we're doing.

So on a normalized basis, you're looking at around mid-300s on our guidance.

Got it.

And then -- so if it's normal, let's call it, mid-300s, then how do we think about the trajectory of that, like in 2020, 2021?

Our view is we should see acceleration.

And a couple of reasons.

One is we're realizing some of the benefits as we move into the integration.

But also one of our benefits, if you look in the prior, was a lot of the initiatives we've been doing around net working capital, and we saw a lot of meaningful improvements on receivable -- accounts receivable and accounts payable.

And what we're really focusing our efforts on now, and we had mentioned entering the year and also going forward, is driving sustained improvement on inventory.

I think another point is we're continuing to work to optimize our ETR and reduce our cash taxes.

And we'll see some opportunities, both in our existing term loans as well as new term loan coming in, on interest expense -- on cash interest expense.

Okay.

Got it.

That's helpful.

And then maybe clarifying something on the Energy side of the business with the new expectations in upstream.

If I recall correctly, the comps get a little more difficult in the third quarter from a growth perspective.

We talked a little bit about decremental margins.

And so is the right way to kind of think about the cadence for the rest of the year, that decrementals could remain maybe similar to 2Q and 3Q and then get better as we progress to 4Q?

Or how should we think about that in the context of the comments that you made earlier, Vicente, around pricing for fluid ends getting a little bit worse?

I mean in terms of the decremental, spot on to that, Joe.

And in terms of the cadence, yes, it's about $100 million per quarter kind of the cadence, revenue-wise.

That's why we kind of called out the steady, roughly 33 -- $30 million to $33 million per month.

But yes, so cadence of grow -- of revenue in the $100 million per quarter with 40-plus percent decremental.

Our next question comes from Nicole DeBlase of Deutsche Bank.

So I just want to start with EBITDA expectations for Industrials and Medical.

You guys have been doing a really good job, seeing really nice year-on-year margin expansion in the first half for both segments, I think a little bit in excess of what you would have expected.

And so are you still looking for 100 bps of year-on-year expansion in EBITDA margins for the full year?

Or has that stepped up a little bit within the guidance?

No.

I think still consistent to the guidance, we are looking at Industrials to be about 100 basis points and the Medical to be slightly above 100 basis points.

Okay.

Got it.

That's helpful.

And then if you could talk a little bit more about what you're seeing with respect to pricing in Energy?

I know you talked about fluid ends becoming a bit weaker, how much is pricing down?

And then have you seen any signs of weaker pricing across any of the other products, services that you supply within upstream?

Sure, yes.

So I mean if I categorize it in -- and again, the only place if I kind of carve out is the upstream side of the business, right, the upstream side of the Energy segment.

So it's not across the entire Energy segment.

Again, our NASH downstream business continues to do very well on price positioning.

Within the upstream business, you have the different buckets of pumps.

I mean obviously very little pumps going out in the market, but those pumps are going at a very good -- still continue to be kind of good price momentum.

And repairs service stable.

Consumables is actually something that difficult to measure the price because our ASPs continue to go higher because of new technology that we're launching.

So again, there you honed in on fluid ends, and particularly, there's just been a lot of -- there has always been a bifurcation of -- in the market of kind of very low-cost fluid end players, has always been that in the market and what we consider to be -- us to be the premium player in the fluid end.

The big difference is that our fluid ends, as I mentioned in the remarks, could last -- could be changed maybe 1 or potentially 2 times in the year.

So they're lasting much longer, new technology, but the market continues to drive the prices down on the fluid end.

So overall, if you look at it at an upstream business, low-single digit for overall kind of price reduction, primarily driven by fluid ends.

Vicente, if I could squeeze one more, the short cycle on the Industrial business, a lot of companies have talked about things getting weaker in June and into July throughout the quarter.

Can you just talk about what you saw from a monthly perspective and if you did see any negative momentum as we entered June within Industrials?

Yes.

Nicole, I think we saw it and obviously, we watch this really carefully, the daily order rates on a kind of weekly consistent basis, and -- fairly, pretty stable, I think, in the sense of how we view it.

Again, Americas performing really well.

Europe continues to be very stable.

China is the only one that has seen sequentially from Q1 to Q2 a slight improvement, but pretty -- I wouldn't say volatile, but kind of fluctuating within the quarter.

But again, China is a fairly small piece of the total equation for us.

Our next question comes from John Walsh of Crédit Suisse.

I guess, maybe following in on Nicole's question there, if I hold that 100 bps of margin expansion in Industrials, I'm backing out to like an incremental in the mid-30s, which given what we've seen in the first half performance, would potentially seem conservative.

Is there anything particularly that drives that?

No.

Nothing particularly, John.

I mean I just think that as you saw the team definitely over-delivered in the first half, and we decided to, at this point in time, continue to keep the second half consistent for a full year guidance.

Got you.

And I guess, maybe just a point of clarification on an earlier question.

I think you were asked about some of the channel dynamics at Energy.

Apologize if I missed it, but can you talk about what you're seeing in terms of kind of channel inventory, what's out there in distribution on the Industrial side of the business?

And maybe you got to kind of break that apart by region, because I know that the mix is different across the globe, but any kind of color there around channel inventories?

Sure, John.

I think the easy answer to that is that in the Energy we're really direct business.

So we don't have really a channel in the Energy businesses.

So we go directly -- direct to the customers.

On the Industrials side, where we have mainly distribution, I'd say the majority of that is really in the U.S. But again, these are big-ticket items what we sell, so they're not off-the-shelf items, and our distribution channel does not stock a lot of these items.

We also have a very sophisticated network in the U.S., where we can see inventory levels, if there is any, particularly mostly in the aftermarket.

And it's consistent, no increase, no decrease, no -- I mean, so it's consistent to what -- with what we have seen historically.

So I wouldn't say that there is anything to be worried about on the dealer channel.

Your next question comes from Igor Levi of BTIG.

Could you guys talk a bit more about what you see in the electric frac market as well as comment on threat from DuraStim concept, which competes directly with your pump?

Do you see risk of losing share when the new build frac market recovers?

And how are you addressing this risk?

Yes.

So maybe -- I mean think about it, I mean there is -- think about it kind of from a proven technology.

I mean there is e-fracs right now in the market, right?

There is several -- there is like 2 OFS that are basically 100% electric, and they use our pumps.

I think the confusion here has always been that our pumps do not work on the e-frac, and our pumps work, whether it is electric, natural gas or diesel.

Now what we have done, as you saw here in the announcement, is that we're launching a new pump that is going to be optimized for turbine generation and other aspects that we're very excited about in case customers want to pursue that angle.

But I think we still believe that if oilfield service customers, they want to participate in the e-frac cycle, that the best is to go with proven technology.

And the proven technology is hydraulic fracturing, reciprocating compressors or pumps, which is basically what we have out there that could be retrofitted easily to get connected to any type of energy power source.

I don't think to like to comment against competition.

I mean, I think -- again, I just highlight that the technology that we have is proven, that our team continues to evolve in innovation, and here in the second half, we're pretty excited about talking about even more new technology that we're launching in case that e-frac is a trend that customers want to pursue.

Great.

And then given the lower EBITDA guidance for 2019, is there any risk whatsoever of Ingersoll Rand trying to renegotiate the terms of the deal?

No.

No.

Definitely not.

And that's kind of why we still feel, and we talked about the -- I mean we're very excited about what we're seeing.

The outlook here beyond where we're going to have a company where upstream will be definitely less than 10%.

So a lot of these kind of cyclicality kind of noise moves away to even lower decibel levels, so to speak.

And we're confident on the synergies and confident on -- continue to have a long view here moving forward.

Our next question comes from Nick Amicucci of UBS.

This is Damian Karas.

Can you hear me okay?

Yes.

Apologies, I lost my prior connection.

So just a couple of follow-up questions on the guidance.

You've put a rather precise number down there of down 30% for the upstream business.

Could you maybe just discuss the range on the full year for EBITDA?

Is that range really driven by the upstream business?

And how are you thinking about the scenarios that would either sway it to the low end or possibly high end and above?

Yes.

So it is definitely 100% swayed by the upstream side of the business.

And the way to think about it is that, if you remember, coming into the year, we viewed that OE pumps were going to decrease about 50%.

We're now seeing that OE pumps may decrease 60% to 70%.

And coming into the year, we saw fluid ends, service and repair could be flat.

And we see now fluid ends, service and repair to be down about 20%, with the rest of the consumables to be about flat.

So I mean that's kind of the change and -- but as we see that utilization rates increase -- I mean I made a comment on my remarks that utilization rates are a multi-quarter low right now.

And as utilization rates may pick up in the second half, then this dynamic will definitely change.

However, I just think that at this point in time, we just want to be prudent with the second half and call it the way we see it, which is opaque second half, just based on this too much capacity, customers stacking fleets, in some cases, cannibalizing some of the fluid ends, that's why we see fluid ends kind of decrease.

So in some regards, some cannibalization is happening in the field, and I think it's just going to create some solid pent-up demand later down the cycle when things start picking up again in utilization.

Okay.

That make sense.

And I guess given that the guidance revision is totally stemming from upstream, you did mention, however, some ongoing project delays in the mid and downstream part of the business into 2020 possibly.

Could you maybe just help reconcile that commentary?

Or were you just outlining the possibility of some further project deferrals, but you're still confident that those projects that were projected for 2019 are going to execute as planned?

Yes.

I think that -- and that commentary was really more on the orders.

I mean because obviously, a lot of these kind of longer-cycle projects, they tend to have a lead time of 12 months.

So as these large projects, if they start getting delayed into later in the year, it just means that obviously, we're not going to ship them this year, but it's really more on the orders and not so much that we're counting on for those to be executed for shipment in this year.

Our next question is a follow-up from Nathan Jones of Stifel.

Just a couple follow-ups.

Firstly, on the upstream Energy business.

Typically, when you see a downturn here, customers are cannibalizing unused pumps for parts.

Do you think that is going on at the moment, and that what you're seeing in terms of your demand is actually lower than what the overall market demand is, kind of akin to a destocking?

I mean I think the way we think about it is that there is potentially some kind of cannibalization in the sense that because there is a lot of fleets that are getting stacked.

And as our OFS customers, they look at maintenance cost and they look at ways to optimize.

I mean, of course, if they see a fluid end for a fleet or fluid ends in a fleet that is stacked and not going to get utilized in the quarter, they're obviously going to take that fluid end and put it to use.

So I think there is -- that's why fluid ends is the high ticket consumable item that as -- OFS's, they tend to protect their budgets.

They will definitely utilize what they have out there, even if it includes removing it from a fleet that is stacked up.

That's why we sometimes like in the past always talk about these consumables, because the consumables is really the more ongoing activity.

Consumables, we continue to see very steady demand.

We actually saw sequential improvement of about 10% from Q1 to Q2 on consumables.

And we don't see performing different from the market.

I mean we don't foresee -- I mean we don't believe, based on all the data we see, that we're losing any share at this point in time.

Okay.

And then just one more on the guidance.

You talked about today some larger projects you're expecting to ship in mid and downstream Energy in the fourth quarter.

And you also talked about a couple Industrial things that were due to ship in December.

Given the kind of economic environment that we're in that we're starting to hear more about things slipping to the right, what's your level of confidence that those things actually do go in the fourth quarter and in December and don't slip to next year?

I mean it's very normal and kind of typical for us to see large projects here at the end of the year.

Customers tend to take, for these kinds of large projects, they tend to take it in many cases because then they can work on installing them through the holidays in some cases.

And we don't -- at this point in time, we don't foresee these getting delayed, but something that clearly, Nathan, we track and monitor very, very carefully.

This concludes our question-and-answer session.

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

Yes.

Thank you for the interest in Gardner Denver.

As we sit here, we still sit here very excited about the performance that we're driving in our business, and with a very great view around our long-term view for our shareholder value creation and how we continue to get really excited as we continue with the integration plan with Ingersoll Rand Industrial businesses that we feel is going to create a fantastic premier company moving forward.

So with that, thank you, everyone.

And look forward to connecting soon.

Thank you.

The conference has now concluded.

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