Earnings Call: Q1 2019

Apr 30, 2019

And welcome to the Gardner Denver First Quarter 2019 Earnings Conference Call. All participants will be After today's presentation there will be an opportunity Please note, this event is being recorded. I would now like to turn the conference over to Vic Kenny, Investor Relations Leader. Please go ahead. Thank you, and welcome to the Gardner Denver 2019 First Quarter Earnings Call. I am Vic Kinney, Gardner Denver's Investor Relations leader. And with me today are Vicente Reynal, Chief Executive Officer and Neil Snyder, Chief Financial Officer. Earnings release, which was issued this morning, 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, 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 first quarter highlights as well as our segment results and 2019 guidance. We will conclude today's call with a Q and A session. As a reminder, we would At this time, I will now turn it over to Vicente Reynal, Chief Executive Officer. Thank you, Vic and good morning to everyone. Starting with Slide 5, I would like to start with a brief overview of the first quarter. Overall, first quarter was a balanced quarter. With strong execution across our commercial and operational initiatives. We delivered revenue and adjusted that were in line with our expectations and continue to show solid momentum on cash generation. Due to our performance in the first quarter, we are reaffirming guidance for a total year. Let me provide a little bit more color on the financial highlights in the first quarter. Starting first with orders. We saw an order decline of 9% excluding FX, which was heavily impacted by the non dynamics in upstream energy of minimal new pump orders for new frac fleets. This drove nearly $60,000,000 of expected orders decline. And when excluding upstream energy, the rest of the portfolio grew 3% excluding FX. As the broader markets continue to remain quite resilient. Revenue grew 4%, excluding FX, with solid mid single digit growth in the industrial segment and double digit growth in our midstream, downstream and medical businesses. This comes on top of very strong growth of 22% in the prior year as the teams continue to deliver above market growth through the utilization and execution of our Gardner Denver execution excellence tool or GDX. While we did see the expected pressure on upstream energy revenues that we indicated during our last call, I am particularly pleased with the resilient performance across the balance of the portfolio. And mid and downstream grew 12% excluding FX. Adjusted EBITDA declined 5% $140,000,000 or down 2%, excluding FX, and margins declined 130 basis points to 22.6%. The results were in line with our expectations and the declines in both adjusted EBITDA and margin were largely attributable to the decrease in upstream energy revenues as well as higher corporate costs due to prior year legal expense recoveries that did not repeat in the current year. Despite these factors and other known headwinds like FX and tariffs, the team executed extremely well. Including triple digit basis point margin expansion in the industrials and medical segments, targeted cost initiatives like innovate to value or I2B are showing positive impacts. I am very pleased with the continued momentum we see on cash generation, which speaks to our discipline cash and working capital management. Free cash flow in the quarter was $55,000,000, up 9% over prior year. In addition, net operating working capital as a percentage of sales continued a positive trend we have seen over the past few quarters at 24.9%. Which is a 430 basis points improvement versus last year. The solid cash and adjusted EBITDA performance led to net leverage of 2.0 times. In addition, we made a $27,000,000 debt repayment within the quarter as we continue to focus on prudent debt reduction and managing our gross leverage levels. As we have stated previously, we will continue to remain disciplined on capital allocation and balanced debt paydown as well as opportunistic share repurchases within M And Turning to Slide 6, our commitment to our 4 pillars of strategy remains unchanged and driven by the tools and processes of GDS. I hope everyone had a chance to attend or watch our recent Investor Day that we hosted in mid March. Speak to the passion that the entire team has around deploying our strategy across every aspect of the business and driving ongoing profitable growth Moving to Slide 7, I will provide more color on the operating performance of our segments. I will start with Industrial segment where we continue to see good momentum on both commercial and operational initiatives. The Industrial segment's 1st quarter order intake was up 4% excluding FX at $335,000,000. Revenues in the quarter were $318,000,000, up 6%, excluding FX. This resulted in a book to bill of 1.05, which is a good sign as we enter the year that core markets remain relatively healthy. In terms of the product lines, we continue to see relatively stable performance in core oil lubricated compressors, which were up low single digits. And we have lighted in the past, the unique composition of our portfolio, around a well balanced portfolio with niche applications, and this allows to show continued resiliency, even in more difficult market conditions. One such product is highlighted on the bottom of the slide, which is our Leroy compressor. The Leroy business was purchase into the portfolio in mid-twenty 17 and introduced a line of gas compressors to complement our portfolio of air compression technology. When coupled with our existing Gardner Denver distribution channel in the Americas, we're now seeing strong growth in niche industry of biogas. Where we have seen solid double digit growth. In addition, we continue to see solid demand for our niche products in Europe and Asia in end markets like food, pharma, transportation and marine. From a regional perspective, the Americas continued to be the strongest region with high single digit growth on both revenue and orders in the quarter Europe continues to be relatively stable with low single digit revenue and orders growth, excluding FX. Despite some of the macro concerns surrounding Europe, that have persisted through the quarter, we saw a good balance of high single digit to double digit growth in many niche products. With generally flattish growth in oil lubricated compressors, as solid demand in Germany offset some of the slowdown from areas like Italy and France. In Asia Pacific, we saw slight growth in China, largely driven by niche products like blowers vacuums and high pressure compressors. The growth is very encouraging, and we continue to monitor the market closely, given ongoing noise around trade tensions and tariffs. Moving to adjusted EBITDA. Industrials delivered $71,000,000 in the quarter, up 12%, excluding FX. 1st quarter adjusted EBITDA margin was 22.3%. Up 120 basis points versus prior year. The year over year margin increase was achieved despite ongoing headwinds from FX, and tariffs. And this speaks to the benefits we're seeing from initiatives like pricing, aftermarket growth, and I2B. Moving now next to the energy segments on Slide 8. Overall, the energy segment performed in line with expectations. Given the non decline in upstream revenues, partially offset by solid execution in the mid and downstream businesses. The Energy segment 1st quarter order intake was $208,000,000, down 26%, excluding FX. Driven largely by the previously mentioned $60,000,000 in pumps from the upstream business that did not repeat again this year. In the mid and downstream business were much more stable and up low single digits, excluding FX, which is in line with our expectations. Revenues in the quarter were 2.33 with upstream revenues down 16%, excluding FX, offset by growth in both the mid and downstream businesses which both showed strong double digit increases. So driving now into the components of energy, let me start first with the upstream. Orders were down 41% and revenue was down 16%, both excluding FX. With expected original equipment declines as the primary driver. As you recall from our last earnings call and our recent Investor Day, We indicated that Q1 was going to be a low point in the year with sequential increases progressing through the year. We still see that as business where more than 75% of our revenue is reoccurring aftermarket, and specifically consumables continue to trend very well. Consumables are the closest point to activity and were up 17% in terms of revenue in the quarter. In particular, our 2 new consumable offerings of packing and plungers continue to see solid market penetration with strong double digit growth. In terms of the market in general, we continue to believe that 2019 will be a transitional year as the market waits for the commissioning on new pipelines and gradual sequential improvement, particularly in the second half of the year. The docks, which is drilled but uncompleted well count, continues to remain healthy at approximately 8500 wells as of the end of March, which bodes well for future activity levels. And while the market is in the bid of a transitional period, I am very encouraged by the steps in innovation and partnering with our customer base that our team continues to make. The picture at the bottom of the page shows an electric power frac truck with 2 Gardner Denver Thunder pumps packaged together. Electric frac is a concept that has gotten a lot of attention and discussion as of late, as an alternative to conventional diesel power frac fleets. And I am very pleased that Gardner Denver has been on the forefront here, partnering with several leading pressure pumpers and equipment providers who are utilizing electric power frac fleets. This truck packages 2 of our leading Thunder pumps, which allows for up to 6000 of hydraulic horsepower, with increased levels of efficiency. Innovations like this and strong partnership with leading providers of frac services will continue to drive profitable growth as we look ahead. On the mid and downstream side, revenue was collectively up 31%. And orders were up low single digits, both excluding FX. We did have 2 larger project shipments in the midstream business with collective revenue of approximately $10,000,000, which drove book to bill for the combined mid and downstream businesses to approximately 1. However, the downstream business on its own had a book to bill of 1.16, as it is typical for the beginning of the year as we build backlog for the second half of the year. Overall, the market continues to trend well as the project funnel remains quite healthy and we continue to see increasing demand for both industrial like process equipment as well as projects tailored towards environmental applications and regulatory emissions. The Energy segment delivered adjusted EBITDA of $60,000,000 in the first quarter, which was down 10% to prior year, excluding FX. As a percentage of revenue, 1st quarter adjusted EBITDA was 25.7 percent, down 240 basis points from prior year, due to the previously mentioned decline in upstream revenue as well as revenue mix due to lower margins on the 2 large midstream projects. These declines were partially offset by volume growth from the downstream business as well as targeted cost actions and operational efficiency initiatives. While energy margins were down overall, I continue to be pleased with the measures the upstream energy team is taking. As adjusted EBITDA margin remained well above total energy margin profile and in excess of 30%. Moving next to the medical segment on Slide 9. Order intake was solid at $71,000,000, which was down 1% excluding FX. And it's worth noting that this is on top of 11% growth that we saw in the prior year. As we have mentioned previously, many quarters throughout 2018 benefit benefited from large design wins which we do not expect to repeat to the same degree each and every quarter. However, first quarter orders did remain very healthy, and in excess of $17,000,000, which was up 8% from the fourth quarter of 2018. Revenues in the quarter were 4th consecutive quarter of double digit organic growth as the business continues to execute well on innovation and prior design wins. In addition, this put book to bill at 1.03, with Q1 ending backlog nearly 9% higher than prior year. One such win on the gas pump side of the business, it's a high pressure gas pump that was recently specified on a leading clinical molecular diagnostic solution. The Gardner Denver solution provided more efficient flow rates in different altitude environments, which was a critical differentiator for the end customer. Winds like this in high growth end markets like lab and life sciences continue to show the growth opportunity across our gas, liquid, and liquid handling product lines. Medical adjusted EBITDA performance for the quarter was $20,000,000, up 32%, excluding FX. Margins were 28.9 percent, up 260 basis points, versus prior year and can be attributed to strong flow through from the volume increases, continued operational efficiencies in the plant and prudent cross control across the business. Moving to Slide 10 now, as I indicated earlier in the call, due to the strong and in line performance in the first quarter, we are reaffirming guidance for the year. As a reminder, this implies mid single digit revenue growth before the impact of FX in our industrials, Mid And Downstream Energy And Medical Businesses. As well as high single digit to low double digit declines in our upstream business with more pronounced softness in the first half of the year. For total company and inclusive of FX impact, we're expecting low single digit growth on a total year basis. And an adjusted EBITDA range of $680,000,000 to $710,000,000. Now turning to Slide 11, the rest of the key metrics for guidance remain unchanged, including CapEx, tax rate, and year end debt leverage. In addition, we continue to expect to generate in excess of $400,000,000 of free cash flow for the year. And approximately 100% free cash flow to adjusted net income conversion. Overall, we're pleased with the start of the year. And despite many of the macro headwinds that persist, we continue to execute well, both commercially and operationally. We remain confident in our ability to execute on our strategic initiatives and deliver our financial commitments across each of our segments. With that, we will Thank you. We do ask that you please try to limit your questions to one question and one follow-up. Our first question comes from Mike Halloran of Baird. Please go ahead. So first, just on the trends through the quarter and the thought process from here from 2 perspectives. First, on the upstream side, maybe you could give some thoughts on the cadence as you saw demand materialize through the quarter. Obviously orders were soft against a really tough comp that was highlighted coming in. Do you see any different trajectory than you articulated a couple of months back as you look to 2Q, 3Q based on the order book today, the demand outlook, what clients are saying, customers are saying, anything like that? Hey, Mike. No, I think we still see consistency to what we said even at the Investors Day that the 2nd half will be up sequentially to, to the 1st half, but that we will see that as kind of that, at least at this point in time, we still want it to be more prudent and call it out as low to mid single digits, sequential improvement, second half versus the first half. And no real change on the cadence to the first half of the year either Vicente? No, no real cadence to the first. No, that's right. So we still believe that as we said also before, Q1 will be the most pronounced bottom and then slight improvement. Mean, as we go into the 2nd half, better than the 1st half. And can you give that same sort of thought process and commentary on the industrial side of the business particularly with a focus on what you're seeing in your European businesses and in China? Yeah, the, you know, the, the second quarter should be comparable to the first quarter, Mike. I think it's just going to follow the same trends that we typically see in terms of seasonality within industrials. I mean, I think maybe the only one point to call out is that, you know, within Q1 in the quarter, China, we saw really strong exit of the quarter. In in terms of order. So maybe kind of things are getting unlocked in China. So we were watching that carefully to make sure that that level of consistency, continues to happen in the 2nd quarter. And when you say stable 1Q to 2Q, were you talking dollar numbers or were you talking percentage change? Dollar numbers. No, sorry, percentage changes. Great, great. Thank you everyone. Appreciate it. Our next question comes from Joe Ritchie of Goldman Sachs. Please go ahead. Thank you, Joe. So Vicente, can we just, maybe just elaborate a little bit more on just the upstream business for a second? So clearly had a really tough order comp in 1Q. Just what are you hearing from customers right now in terms of like frac fleet stacking and and the demand for OE versus aftermarket? Yes, Joe. So overall, what we're hearing in the market, continues to be similar to what we said, a few months ago at the Investors Day, which is that everyone expects a much stronger second half and particularly fourth quarter as the constraints on the pipeline capacity seem to be, kind of freeing up in the, in the second half with more pronounced on the fourth quarter. So that's kind of from a customer perspective, what we're seeing what we're hearing, and it seems to be more consistent as we move every day, and every week, through the quarter. Obviously, we're going to be at the OTC in a week or so. So we'll, we'll hear more, commentary from others there as well. But at least, it's been consistent so far. In terms of OE and aftermarket, OE still, muted from a new fleet expansion. So we still don't see that, there's going to be any OE pumps that will come for, new fleet expansions. We're definitely seeing, kind of, I call it, momentum on the OE replacement pumps. And there's been quite a couple articles talking about that due to the level of intensity and the hours that the pumps are working, there should be a good cycle coming through on the OE replacement pump. Okay, that's helpful. And then I guess my follow on question is just maybe just talking about industrial margins, another really solid expansion quarter on a year over year basis. Maybe just talk a little bit about your key drivers, what did pricing look like? How much of this was I2V? Just trying to understand what really drove the strength, just given we've seen more mixed performance, I guess, from some of the other industrial peers out there? Yes. So we saw good momentum on pricing. I'll say pricing anywhere between one to two points. You know, the blend of aftermarket continues to improve. So aftermarket, deliver even better growth than the overall total numbers. So that obviously creates a better mix change. I2V, continues to be a good start keep in mind that, that this is really more offsetting some of the tariffs, if you want to put it from that perspective, that we get about $1,000,000 to $2,000,000 in the quarter. So again, I think the work of, I2V and, sourcing activities offsets the tariffs, well, price, and aftermarket mix helped the margin profile. Our next question comes from Julian Mitchell of Barclays. Please go ahead. Hi, good morning and congratulations again. Thank you. Thank you, Julian. No need, I guess, for a capital deployment question. So maybe just on the energy segment, the decremental margins, I guess, pretty severe in Q1 you called out a couple of factors around project shipments in midstream and so forth. But just wondered when you're looking at that decremental drop through in Q1, do we see a much better performance into Q2 or do you think Q2 is down heavily again and then we get the big incrementals on the way back up in the second half? Yeah, Julian, we see, the, the decremental, in the energy, again, driven because of, upstream revenues coming down while the, you know, we saw the large couple of projects on the midstream side of the business that typically come in mean, well below the margin profile of the energy segment. I think, the good point to note here, Julian, as well is that upstream, even though we saw this decrease in revenue, as expected, our margin profile for Upstream is still it was above 30 percent EBITDA margin. So pretty strong, ability to even in a decline, quarter we'll still deliver above 30 percent EBITDA margin, which I think is fantastic for what the team has been able to, to achieve their And I think for going in, as you said, moving forward, obviously, we don't expect these 2 large midstream orders to come through in the 1st quarter that, that should help as we move forward. Thanks. And then my second question, really, I guess, across the business, some shorter cycle companies have complained about destocking in recent months in various regions and vertical markets. Just wondered if you had seen any of that take place across any of your OEM or channel partners in different segments, and how satisfied or relaxed you are today about the status of inventories when you look out across different markets? Yes, Julian, we didn't see that been a concern to us, at least we didn't see that going in the quarter. I mean, I can tell you that, from an industrial perspective, we have most of the dealer channel is in the U. S. And we have actually access to see what their inventory levels and we always maintain and ensure that it doesn't spike up or becomes unhealthy, higher amount. So, you know, what we saw, no destocking, we we just don't allow, you know, it's one of our rules. We just don't want dealers to stock. And then in the other regions, whether Asia Pacific And Europe, for industrial perspective, the amount of dealers, percentage of revenue is much smaller. And I don't think that any of these destocking was definitely an issue for us. Our next question comes from Nathan Jones of Stifel. Please go ahead. Good morning, everyone. Good morning, Nathan. Just a follow-up question on industrial Europe. One of the comments you made Vicente was that you saw a very strong environment in Germany, which I thought was a little surprising. Given some of the macro data, the industrial data that's coming out of Germany. Maybe you can put a final point on that. Is it Germany is good for you because you're gaining market share or you're actually seeing underlying market strength and how you see that particular market progressing for the rest of the year? Yeah, Nathan, I think, we, we, we kind of alluded to, if you remember, our, our kind of niche products momentum where the blowers vacuums for specific end markets could be transportation, wastewater, food, pharma, where we are seeing some good momentum with the solutions that we're driving. I'll say that that is the main driver of, the growth that we're seeing in, in Europe as well as the growth that, that we saw in, in, in Germany. You know, and when we look at the kind of more, related to the industrial, general industrial applications, maybe the core compressor that we saw the, as I kind of stated, maybe kind of flattish or maybe some more softness on that, offset by the more nichey products. Okay. That helps. And then one on upstream energy that's not frac pumps. For the last, I don't know, 6 to 12 months, maybe we've been talking about the potential for a drill pump cycle here at some point. Any update you could give us on the conversations you're having with customers on that front? Yeah. I think, you know, what, conversations continue, I will say, I'll I'll I I don't think that, we haven't, I wouldn't call it as it is, we're not seeing the purchase orders yet, obviously, but conversation continue. And the other good data point that we look is that super spec rigs continue to be at very highly utilization. So, one of our customers is seeing 95% kind of close to 97% utilization of super spec. So, The trend that we see is that more super spec rigs are needed. And as you know, that requires 3 or 4 pumps and there's just not many more pumps to get cannibalized from older generation rigs to this super spec rig. So the trend and the kind of the secular trend that we see, we still see it, and, we still have, kind of high hopes that, it will continue to, and then at some point in time, unlock this, request for drill pumps. But, you know, having said that, we, we, it is not in our guidance. So just to just to emphasize, you know, we we never guided that we will see this drill pump cycle. And obviously, if it comes, we're going to be ready and it should be upside for us. Our next question comes from Josh Pok Rosenzczynski of Morgan Stanley. So, I guess, just given there's some macro volatility out there that maybe in the industrial segment you didn't see too too much of, Can you just give us a sense for kind of entry rates for the business as you got into the quarter versus exit rate did things get better or worse, just some kind of indication on where the trend line should be drawn from here? Yeah, Josh, we saw, maybe I start with, it's kind of the, the, maybe the smaller, smaller of, all of our regions, but you know, the Asia Pacific, in particular, China, we saw good momentum as we exited the quarter. And at least after obviously quite a few quarters of pretty constrained demand in China. We think that things are kind of unlocking there. And it is not just compressors. I mean, it's basically blowers for wastewater treatment applications and other kind of large scale projects So hopefully that continue and that that wasn't just a kind of a one data point in the month of March. I would say for, respectively, to the, to the other, businesses, most of them kind of, I think, consistent to what maybe others saw, things were very slow in January, but merely due to seasonality, I don't think I will call it for anything negatively general in the market conditions. And, and then, obviously, that you could argue that because of a slow start in January, we saw progression, but I will call that more seasonality. That will be for, Americas and Europe. And I think the good thing is that Europe continues to be fairly stable for us. I mean, the team in Europe is doing it from took job, over, over country and the effect of the entire micro slowdown. Got it. That's helpful. And then just one rec was a question on upstream energy. Just thinking about kind of the absolute dollar number of orders, I think kind of in the low 200s here. How should we think about that app solute number trending through the year? Do we start to grow here sequentially? And how do you think about price the cadence on price as we move through the year? I know there's less sensitivity in you guys maybe versus some others out there, but anything you're seeing or any kind of directional moves you expect? Josh, you're referring particularly to the upstream side of the business, right? Yes. I guess the 200 comment it would be orders entirely in energy because stream orders, I don't know specifically, but yes, whatever way you want to put it that would be helpful context for us. Yeah. Yeah. So, so I think, you know, I, I mean, I can kind of break it down into the pieces. I mean, I think from an or let me just begin with the, with the energy side. I mean, I think what we see in the energy side is that, the second half will see, you know, much better momentum sequentially. Particularly the upstream side, as we called out, we expect that that's going to be up low to mid single digits. And then, you know, the interesting fact on the mid and down, Josh, is that typically we get most of the orders in the first half, Q1 and Q2. That's what we called out that order momentum in min and down was actually particularly, fairly good. So we expect that order at an absolute dollars in the second half for mid and down should be expected to be lower. Than the first half, but then maybe offset by the better momentum in orders on the upstream side. Okay. So the absolute dollar run rate maybe, you know, and I know it's over overgeneralizing it, but probably similar from 1Q levels the rest of the year? I mean scaling that up, obviously, sequentially growing. Our next question comes from John Walsh of Credit Suisse. Please go ahead. Hey, good morning, John. Hey. So apologize if, if somebody already asked this, I just hopped on, but medical had a very strong performance this quarter. Just wondering if you can kind of comment on both what's driving the top line and the better margins than we were looking for and then really the sustainability of that going forward. Yeah, John, thanks for the question. I mean, I think the Medical segment, continues to be one that, that we're making a lot of, organic investments It continues to be one that we talked about also our funnel for M and A continues to be fairly, fairly size, fairly healthy. You know, in terms of the performance, yeah, I mean, you can see that the teams continue to execute really well. It has to do in part If you recall, in 2018, our order momentum was really strong. We're seeing some tough comps because of that. Order momentum in 2018 was really strong because of a lot of the new design wins that we achieved in 2018. We're seeing shipment of that, here in 2019, the first quarter. But again, the order momentum continues to do well, even though orders were you can call it kind of flattish, that was on top of 11% growth from last year. And also the absolute amount was, you know, fairly, fairly healthy at $70,000,000, which allowed us to increase our backlog. I'll say it is really great, good execution for our team on the initiatives of, the liquid pumps, liquid handling as we're entering new markets with that. And I'm seeing some pretty nice design wins on that. Great. And then maybe just a follow-up around working capital. It looks like you kind of continue to improve this metric here? I mean, how should we think about the cadence? Is there any noise from channel or tariffs? Or is or is this still just kind of clean execution on driving that down as a percent of sales? I think for us, it remains a strategic focus and we'll be able to continue to drive improvement in particular on the inventory as we move through the year. As we had mentioned, I think, the Investor Day, it's still an area of focus for us. We've been pleased with what we've done with receivables and payables, but we still see upside opportunity as we move through the year on our inventory. This concludes our question and answer session. I would like to turn the conference back over to Vicente Reynal for any closing remarks. Thank you. And once again, thanks, thank you all of you for your, level of interest in Gardner Denver. As we discussed, we have some pretty exciting momentum going on in the company. I want to always reemphasize our big thank you to all of our employees for delivering another great quarter here, or performance and the continued momentum that we have in our company of creating a very unique performance driven culture. So with that, we'll just call it a close and we'll talk to all of you soon at some point in time. Thank you. The conference has now concluded. Thank you for attending today's presentation.