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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, and welcome to Apergy Corporation's Third Quarter 2019 Conference Call.
Your host for this morning's call is David Skipper, Vice President and Treasurer at Apergy.
I will now turn the call over to Mr. Skipper. You may begin, sir.
Thank you. Good morning, everyone. With me today are Soma Somasundaram, President and CEO of Apergy; and Jay Nutt, Senior Vice President and CFO of Apergy.
During today's call, Soma will discuss Apergy's third quarter highlights and market outlook. Jay will then discuss our third quarter results and be referring to the slides posted on our website, before turning the call back to Soma, to discuss the progress on our growth initiatives. And then we will open the call for Q&A.
I would like to remind our participants that some of the statements we will be making today are forward-looking. These matters involve risks and uncertainties that could cause material differences in our results from those projected in these statements. Information concerning risk factors that could affect the company's performance and uncertainties that could cause material differences to actual results from those in the forward-looking statements can be found in the company's press release as well as in Apergy's annual report on Form 10-K and those set forth from time to time in Apergy filings with the Securities and Exchange Commission, which are currently available at the apergy.com. Except as required by law, the company expressly disclaims any intention or obligation to revise or update any forward-looking statements.
Our comments today may also include non-GAAP financial measures. Additional details on reconciliations to the most directly comparable GAAP financial measure can be found in our third quarter press release and slide presentation for this call, which are on our website.
I will now turn the call over to Soma to discuss Apergy's third quarter results.
Thank you, David. Good morning, everyone. I would like to welcome our shareholders, our analysts and our employees to our third quarter 2019 earnings call. Thanks for joining the call.
Our teams executed well through a challenging and tough North American market environment. Strict adherence to capital discipline and spending austerity, by both our E&P and oilfield service customers, impacted activity in the quarter. As the third quarter progressed, U.S. onshore activity level deteriorated, more rapidly than anticipated, resulting in lower-than-expected operational results. However, our focused execution, strong cost discipline and continuous productivity initiatives enabled us to drive strong adjusted EBITDA margin performance and strong free cash flow performance in the quarter.
In the third quarter, we posted $67 million of adjusted EBITDA on $278 million of revenues as we continued to see the effects of capital discipline in the oilfield. While both of our segments were impacted by slowing U.S. activity, Drilling Technologies experienced a steeper-than-expected decline, driven by the sharp decrease in the U.S. rig count as well as the related destocking of polycrystalline diamond cutter inventories by our drill bit customers. The destocking continues to go deeper as our drill bit customers focus on cash generation and spending cuts.
With the E&P operators annual production targets within reach and that the goal of preserving and living within cash flow, our E&P and oilfield service customers pulled back their spending earlier than expected this year. This resulted in a particularly weak month of September for customer spending, and we expect this trend to continue into the fourth quarter. Apergy is meeting the challenges of the current macro environment head-on. During the third quarter and into the fourth quarter, we took restructuring actions to adjust our cost structure. The actions we have taken so far will result in annualized savings of about $20 million. We are continuing to evaluate additional actions and we will start executing on them in the fourth quarter. We are stepping up our productivity efforts and continuing our cost discipline while preserving our technology investments. Our strong margin performance and robust free cash flow generation will continue to reinforce Apergy's position as a top-box company.
With respect to free cash flow generation, we posted outstanding performance on this metric. Year-to-date, we have generated 83% more free cash flow than in the first 9 months of 2018. We intend to carry this momentum through the remainder of the year and deliver another year of solid free cash flow performance.
In line with our capital allocation priorities, we continued to make good progress on deleveraging our balance sheet. We repaid $25 million of term loan debt in the quarter. Since our spin-off, we have repaid $120 million of debt. We remain committed to deleveraging our balance sheet.
Turning to our segments. Production & Automation Technologies segment revenue decreased 5% sequentially, which was driven by lower customer spending for artificial lift products and the other production equipment. Although all of our artificial lift products were affected by the earlier start of E&P budget exhaustion, our Rod Lift product line held up well and was supported by our strong aftermarket service offering as well as customers converting older wells to Rod Lift.
Digital products revenue grew 10% year-over-year, led by our downhole monitoring and production optimization products. From a profitability perspective in the quarter, PAT delivered strong performance, driven by the cost actions and productivity efforts. We feel our PAT segment performance is resilient and strong relative to the market.
Turning to Drilling Technologies. Revenues decreased 22% sequentially in the third quarter. The revenue decline was driven by the sharp 7% sequential decline in the average U.S. rig count, a steeper and longer-than-expected period of customers destocking their polycrystalline diamond cutter inventories and the push out of diamond-bearing orders due to capital discipline by our oilfield service customers. Given the significant impact we are experiencing from destocking, I would like to provide some historical perspective to this phenomenon.
We see inventory destocking cycles during periods of rig count declines. During inventory destocking, we see impact from 2 levels of destocking. First is our oilfield service customers rightsizing their drill bit fleet to lower activity level. This includes lowering drill bit build rate, readjusting and redeploying global field inventories. The second level of impact is rightsizing of our cutter inventories themselves. This involves lowering safety stock levels, increasing use of reclaimed cutters from older bits and optimizing global inventory by moving excess inventories to wherever needed around the globe. Hence, during destocking, the Drilling Technologies revenue will fall faster than rig count and during restocking period, our revenues will significantly outpace rig count growth. This is a temporary phenomenon. We have included a graph showing this historical perspective on Slide 8 of our earnings slide deck.
Currently, we are seeing a more pronounced level of destocking in the second half relative to rig count declines due to the focus on cash generation and spending austerity by our oilfield service customers. Based on our experience from prior cycles, given the steepness of destocking, we expect a sharper recovery as inventory level normalizes and activity improves.
We have been through these cycles and situations before. We have a well-hold playbook to manage this. We have already reduced headcount appropriately in the segment to match the lower activity levels. We continue to preserve our technology investments in the segment to protect and expand our leadership position.
Our Drilling Technologies team is executing well during this challenging market, preserving our share position with key customers. And we are positioned well to capitalize as the activity improves and our customers start the restocking cycle.
Looking at our business geographically. While North American activity was soft, international markets continued to remain a bright spot in 2019. Apergy's revenues outside of North America grew 13% year-over-year, led by Middle East region. Both segments recorded year-over-year growth outside of North America.
Additionally, we made a strategic investment in a startup manufacturer of sucker rods in Argentina. This investment will help us to advance our growth in South America.
Before I turn the call over to Jay to take you through the details of the consolidated and segment financial results, let me take a few minutes to share our view of the current market for our products. For the fourth quarter of 2019, we expect continued weakness in U.S. onshore activity, driven by a traditionally lower seasonal activity as well as further impact from the customer trends we saw in the third quarter. This includes E&Ps restraining spending as they look to land their 2019 capital budgets within cash flow as well as additional U.S. rig count declines. We also expect our oilfield service customers to extend the destocking of their polycrystalline diamond cutter inventories into the fourth quarter as they adjust to lower drilling activity and adhere to capital discipline.
We expect our PAT segment performance to remain resilient. And outside of North America, we expect the international markets will continue to see growth, and we intend to capitalize on these opportunities.
For these reasons, in the fourth quarter, we expect Apergy to post a sequential decline in revenue and adjusted EBITDA. Additionally, within our Drilling Technologies business, due to the steepness of the declines, we are likely to experience higher than normal decrementals as we continue to preserve our technology investments.
Given the short-cycle nature of our business and added uncertainty due to customers destocking, visibility continues to remain challenging. Therefore, we will provide an update to our fourth quarter outlook in early December.
We do expect activity levels to sequentially improve from current levels as we enter 2020, driven by new budgets and restocking by our drill bit customers as they prepare for improved activity levels. We continue to remain focused on the factors under our control, including advancing our growth initiatives, maintaining cost discipline, implementing productivity improvements and generating free cash flow. Although the current market drop is challenging, our product lines remain highly profitable with long-term growth opportunities. We are well positioned to continue to deliver top-box performance, given our margin resiliency and free cash flow generation capabilities.
Now let me turn the call over to Jay.
Good morning, everyone. As David mentioned, I'll be referring to the slides posted on our website. Beginning with Slide 4. For the third quarter, revenue was $278 million, a decrease of $38 million or 12% compared to the third quarter of 2018, and a decrease of $28 million or 9% sequentially. Excluding the effects of acquisitions and divestitures, revenue was down 11% compared to the year ago period.
The year-over-year revenue decline in North America was $44 million or 16%, partially offset by international revenue growth of $6 million or 13%.
Adjusted diluted EPS was $0.27, down $0.10 when compared with the third quarter of 2018 and $0.08 sequentially.
Cash flow from operating activities was strong at $64 million in the third quarter, up $30 million from the year ago period and $25 million compared to the second quarter of this year.
In the third quarter, the adjusted working capital contribution to cash flow improved compared to the second quarter due to continued efforts to reduce our accounts receivable balances and draw down on inventory.
Capital spending in the quarter was $9 million. Additionally, in the quarter, we used $12.5 million of available cash to close on the acquisition of a digital technology, which is strategic to our artificial lift portfolio.
Turning to Slide 5. We're currently navigating in a challenging market environment in North America. Looking at rig count, the average U.S. rig count declined 7% sequentially in the quarter, with the end-of-period rig count being down 11% compared to the end of June. The year-over-year change in rig count at the end of September was down 18%.
For 2019, North American E&P capital spending is forecasted to be down in the high single digit, as E&P operators continue to remain disciplined about their spending and living within cash flow.
Moving on to Slide 6 and looking at consolidated third quarter performance. Net income in the quarter was $14 million and diluted earnings per share was $0.18. After adjusting for the impact of spin-off, environmental remediation charges and restructuring-related items in the quarter, adjusted net income was $21 million, resulting in diluted earnings per share of $0.27.
We generated adjusted EBITDA of $67 million during the third quarter, a decrease of $11 million compared to $78 million in the third quarter of 2018. Sequentially, adjusted EBITDA decreased $8 million from $75 million in the second quarter. The year-over-year and sequential decreases were primarily driven by the sharp decrease in U.S. drilling activity in the third quarter, a steeper and longer period of oilfield service customers destocking their polycrystalline diamond cutter inventories and the pushout of diamond bearings deliveries. We also experienced lower E&P customer spending on artificial lift products and other production equipment.
In the third quarter, net interest expense was $10 million, which was 5% lower than the second quarter as we're seeing the benefits of our deleveraging efforts.
In the third quarter, we funded a strategic technology acquisition and repaid another $25 million of term loan debt from available cash. Since the completion of the spin-off on May 9 of last year, we've repaid $120 million of term loan debt or 17% of the initial debt taken on at the time of the spin.
Our effective tax rate in the third quarter was 23%, which was within our guidance range.
In the third quarter, we invested $9 million in capital expenditures, including growth capital associated with surface equipment for ESP leased asset portfolio.
Current quarter capital spending was lower compared to the $14 million of investments made in the third quarter of 2018. It was also down sequentially, as we continued to be focused on capital discipline and aligning capacity to market activity to ensure a continued strong return on investment.
Our free cash flow conversion from adjusted EBITDA was very strong at 83% in the third quarter of 2019 and free cash flow as a percent of revenue was 20%. Both ratios improved sequentially and were positively impacted by the reductions in adjusted working capital and capital discipline around capital investments during the quarter.
Free cash flow conversion from adjusted EBITDA for the first 9 months of 2019 was 43%, substantially ahead of the 23% through the first 9 months of last year.
Turning to Slide 7. Production & Automation Technologies revenue finished at $223 million, a decrease of $18 million or 7% from the third quarter of 2018 and a decrease of $12 million or 5% sequentially. Excluding the effects of previously announced acquisition and divestiture activity, revenue declined 6% compared to the year ago period. The year-over-year decline was due to lower E&P customer spending in North America, partially offset by international growth. The sequential decline was due to reduced customer spending for both our artificial lift products and other production equipment.
Adjusted segment EBITDA of $53 million increased $2 million or 4% compared to the year ago period, driven by cost discipline and a high level of productivity benefits, which offset some loss of operational efficiency as a result of the lower volume. Adjusted segment EBITDA increased $2 million sequentially or 3% from $52 million in the second quarter of 2019 due to strong cost reduction actions and the productivity benefits in the quarter. Adjusted segment EBITDA margin was 24% compared to 21% in the third quarter of 2018 and 22% in the second quarter of this year.
Regarding our ESP leased asset program, upfront capital investment in the downhole cables and pumps, net of customer reimbursements at the conclusion of the lease, is reflected in our cash from operating activities. This investment was $6 million in the third quarter, which is down compared to the second quarter levels as we scale back investments as a result of slower E&P customer spending.
Through the first 9 months of 2019, we've invested $37 million in cables and pumps, net of customer requirement -- reimbursements.
For the full year of 2019, we've lowered our estimates and now expect that we will invest between $40 million and $45 million, net of customer reimbursements, and the cash from operating activity section of our financial statements supporting the leased asset portfolio.
Moving to Slide 8. Drilling Technologies posted revenue of $55 million, representing a decrease of 27% from the third quarter of last year, compared to a 7% decrease in the worldwide average rig count and a 12% decrease in the U.S. average rig count. The $20 million year-over-year decrease in revenue was due to the sharp decrease in U.S. rig count, which caused customers to aggressively destock their polycrystalline diamond cutter inventories.
Additionally, in the third quarter, revenues for diamond bearings was $7 million, down from $9 million in the year ago period as oilfield service customers push out orders due to the effects of capital discipline.
Compared to the second quarter of 2019, Drilling Technologies revenue decreased 22% due to the sharp drop in the U.S. rig count as well as customers continuing to destock their diamond cutter inventories throughout the quarter. We estimate the destocking had a negative impact of $12 million against our Q3 results. In addition to the impact of destocking, the reduction in deliveries of bearings due to capital discipline, also had a negative impact on the sequential revenue.
Adjusted segment EBITDA decreased 43% to $17 million in the quarter from $29 million in the third quarter of 2018 due to the lower volumes in the quarter. As we previously shared, we experienced higher decrementals to adjusted segment EBITDA in Drilling Technologies business during periods of sharp declines in revenue. Sequentially, adjusted segment EBITDA decreased 38% from $27 million in the second quarter due to the steep revenue decline.
Adjusted segment EBITDA margin was 30% in the quarter compared to 38% in the second quarter of 2019 and 38% in the third quarter of 2018, as cost actions taken in the current quarter were only able to partially offset the impact to the revenue decline.
As you can see in the chart at the bottom of this slide, we provided a historical perspective of how Drilling Technologies business is affected by significant changes in the rig count over short periods of time. As Soma shared earlier, what's clear from the chart is that when there is a significant change in rig count, we will tend to underperform on revenues from rigs are coming out of service, as our oilfield service customers will execute their destocking plans. As you can see, the destocking impact can have an immediate exaggerated impact on quarterly revenues and earnings and this is the primary driver of our current quarterly segment results.
Similarly, Drilling Technologies business will tend to outperform on revenue when rig count is increasing, as customers restock cutters for higher levels of drilling activity. We've experienced these cycles several times over the past decade. And as we've demonstrated, exiting the quarter, we'll continue to align our capacity to match market activity levels.
Moving ahead to Slide 9, on the balance sheet. Third quarter ending debt, net of debt discounts and deferred financing cost, was $589 million. Cash at the end of the quarter was $41 million. We repaid another $25 million of debt on our term loan during the quarter, consistent with our commitment to our capital allocation priorities, which includes funding our organic CapEx needs tied to our growth accelerators as well as reducing our leverage through debt reduction.
At September 30, Apergy's total leverage ratio was 2.0x and our available liquidity was $285 million.
Turning to Slide 10. Due to the current market backdrop, we're providing a wider range for fourth quarter guidance. And we'll also publish a mid-quarter update to our guidance in December.
For the fourth quarter of 2019, we expect consolidated revenue in the range of $255 million to $270 million and adjusted EBITDA in the range of $53 million to $63 million. The sequential declines in revenue and earnings are due to a further reduction in U.S. drilling activity and associated customer destocking of polycrystalline diamond cutters, for which we estimate an incremental $5 million impact in the fourth quarter.
In addition, we anticipate continued delays in bearings deliveries due to spending discipline by our oilfield service customers.
On the Production & Automation Technologies segment, while the portfolio is more resilient to fluctuations in E&P spending, we do expect an earlier start to E&P budget exhaustion relative to the prior year.
Finally, we also anticipate a charge of approximately $1 million, which is built into our guidance, pertaining to legal expenses that we expect to incur in defense of our intellectual property portfolio.
We estimate that interest expense will be $9 million in the quarter, and that our depreciation and amortization expense will be approximately $30 million.
Our effective tax rate is expected to be in a range of 22% to 24% in the fourth quarter.
Our full year capital spending forecast continues to be approximately 2.5% of revenue for infrastructure-related growth and maintenance, plus an additional $10 million to $15 million for capital investment and surface equipment for our portfolio of ESP leased assets, which is revised down from our previous guidance of $15 million to $20 million as we scale back capital spending to match business activity and maintain our strong cash flow and return on investment.
For the full year of 2019, we estimate adjusted EBITDA to free cash flow conversion of approximately 45% to 50% and free cash flow as a percent of sales of approximately 10% to 11%, with free cash flow being defined as cash from operating activities plus capital expenditures.
I'll now turn the call back over to Soma for some closing comments before we open up the lines for Q&A.
Thank you, Jay. I would like to update you on our progress on the key growth initiatives for 2019 and beyond.
On the ESP growth initiative, in the third quarter, we generated our first revenue from ESP installations in the U.S. with one of the major international oil companies. We have been awarded additional wells with this customer, and we are well on our way towards growing our share of wallet with this customer. We are also making progress on qualifying with other majors in the Permian basin.
With respect to the operational issue we experienced in Bakken in Q2, I am pleased to report that we have completed the needed improvements and we are starting to see recovery in revenues as we exit the quarter.
Our second growth initiative is focused on existing well conversions to Rod Lift as production declines. In spite of a difficult U.S. onshore environment, for the 12 months ended September 30, 2019, we achieved a mid-single-digit revenue increase in our Rod Lift product lines in the U.S. We believe that our strong brands and the position we have in the market will enable us to continue to capitalize on the growing pool of available Rod Lift conversion candidates.
Our third growth initiative involves driving significant growth of our digital product revenues. We are continuing to develop and deploy fit-for-purpose solutions, designed to improve customer productivity and operational economics as well as growing our software-related recurring revenue stream. Our digital revenues grew 10% year-over-year in the quarter.
During the quarter, we closed on the acquisitions of digital technology, which is strategic to our artificial lift portfolio. We are continuing to invest in developing smart-edge hardware and artificial intelligence models that enhances our ability to predict failures, increase in size and prescribe corrective actions to our customers to improve their efficiency.
Our fourth growth initiative is the continued innovation and advancement of our diamond sciences technology. In the third quarter of 2019, our Drilling Technologies segment had 22 new patents issued, bringing the total issued patents since the beginning of 2008 to 785. We continued to preserve our investments in this area, even during weaker market activity, to expand our competitive and share position.
Our final growth initiative is focused on driving continued adoption of our diamond bearings in downhole applications. Year-to-date, revenue in this product line is up 34% compared to the first 9 months of last year.
In the near terms, due to capital discipline, many of our customers have pushed out their diamond-bearing orders as they look to reduce spending in the current market environment.
Strong capital discipline by customers may slow the adoptions from time to time, but given the compelling economic benefits of diamond bearings, we are confident we will continue to see adoption in the coming years.
Additionally, in the third quarter, we displayed our diamond bearings technology at the Water Environment Federation Annual Technical Exhibition in New Orleans as part of our efforts to diversify outside of oil and gas for this important technology.
Before I open the call for questions, I want to share another validation of our customer-centric strategy. We achieved the highest Net Promoter Score amongst artificial lift providers for the fourth consecutive year in an independent survey of over 300 qualified customer respondents conducted by Kimberlite.
For 2019, Apergy earned a Net Promoter Score of 43% compared to the industry average of 24%. Our next closest competitor achieved 15%. Net Promoter Score is a measure of customer loyalty. We believe this result is a validation of our customer-centric strategy and more importantly, the dedication and hard work of Apergy employees in improving the lives of our customers.
Finally, I want to thank all of our employees for their continued efforts and passion in improving the lives of our customers, our employees, our shareholders and our communities. I am proud of their accomplishments, and it's a privilege to -- for me to lead such a great team.
With that, I would like to open the call for questions.
[Operator Instructions] Our first question comes from Brian Hope (sic) [ Byron Pope ] of Tudor, Pickering, Holt.
Yes. Just as a look at Production & Automation Technologies, I'm struck by the EBITDA margin improvement sequentially, and it sounds like some of that was a function of the cost reduction efforts that are already underway. But Soma, could you speak to was there a mix issue at play there as well?
Yes. So, Byron, I would say that it's a combination of things. One is the -- definitely, the cost reductions had an impact. The mix was favorable. But the productivity improvements -- as you know, we are continuously executing these productivity projects. And those productivity projects in the quarter yielded a much higher than anticipated benefit. So in our guidance going forward, we have normalized that back because we don't expect the mix -- sometimes those productivity projects, the timing of when we get the benefit. So there was an impact of the productive -- higher-than-normal productivity improvement as well.
Okay. And then just in the context of the Q4 guidance, while we're on that topic, could you just remind us -- I realize that you guys are expecting earlier-than-normal maybe budget exhaustion from some of your customers. But could you just remind us of the seasonal elements within the Production & Automation Technologies portfolio to be mindful of?
Yes. So the seasonal elements, because as you know, when you think of our artificial lift, they tend to be mostly book-and-ship type product lines, very short cycle, book-and-ship, pump shops and things like that, right? So the seasonal aspect is the holiday period, the number of working days, the holiday period that affects us. And second is the budget exhaustion by E&Ps, that affects us. And then the -- lastly, we typically see lower absorption during -- in our manufacturing plants during holiday period as well. And from time to time, we'll also see weather impact, whether it is in Bakken or some times even in Permian where the access to the well site can we restricted. So from time to time, we see that as well.
Our next question is from Dave Anderson of Barclays.
I also like that chart quite a bit what Byran was just pointing out there. One thing I was kind of noticing there is that, if you look historically, it seems like the restocking tends to be kind of 2x the size of the destocking side. Am I reading that right? And do you expect that same pattern to go -- going forward here?
Yes. I think, Dave, like you asked, let me give you some more color on that, right? So -- because this is really important. Because this is the first time publicly we are going through this restocking -- destocking-restocking cycles.
So if you look at the data we provided, it's roughly about 60 quarters, going back, right? And out of the 60 quarters, there were only like 14 quarters where the variation sequentially had been within 5%. 6 of the 50 quarter -- 60 quarters had sequential declines, which are more than 20%. And alternatively, we have 12 quarters where the sequential increase had been more than 15% and 5 quarters where the sequential increase had been more than 25%. So there are 2 occasions where there had been sequential declines in 2 consecutive quarters, and that is Q1 '09, Q2 '09. And that next one is Q1 '15 and Q2 '15. But if you look at the subsequent quarter, following 2 sequential decline quarters, had been a sharp recovery. So in Q3 of '09, it went up 19%. And in Q4 of '09, it went up 53%. And then when you look at Q3 of '15, following Q1 and Q2 '15 of sequential declines, it went up 18%.
Now if you look at that pattern, so we had a Q3 2019 decline, we are expecting a Q4 2019 decline. So 2 quarters of sequential declines. So if the historical pattern repeats, we anticipate Q1 or the first half to have a very sharp recovery. And customer commentary to us, particularly from their procurement departments, the customer commentaries have been that they are somewhat concerned that our ability to respond quicker because of the 2 quarters of destocking they have done.
So what we are seeing right now is a level of destocking we normally see during industry downturn. And I personally think that partly it's the function of the capital discipline by oilfield service companies and also the focus on cash flow generation of oilfield service companies. So, Dave, I hope that perspective helps. And I think for us, we really think every time we are seeing it that the recovery will be much sharper, and we have a really well-hold playbook. And we know how to respond to this recovery and capitalize and if you look at our historical performance, you will see that.
So, Soma, one thing I'm kind of wondering about is your international business. We're obviously focused on the U.S. side, but you also have a pretty big international presence. Has that mix changed? If I -- what I'm looking at your historical numbers here, and that chart, has that mix of international versus U.S. changed much, that could maybe have exacerbated this downturn a little bit more than what we've seen in the past?
Yes. I mean this is an interesting observation. Because if you plot the same thing with worldwide rig count, the rig count time series will look less volatile, right? But that doesn't change the volatility in the order rate. And that's partly because the major drill bit manufacturers. When there is a U.S. decline, right, their focus becomes one of destocking, right? So the U.S. rig count tends to have a bigger impact on the destocking process than the international rig count.
Kind of a different question on your digital side, on your lift business. Obviously, it's a growth market for you, and you're very optimistic on the prospects there. You made an acquisition during the quarter, I know it was a small one. But could you just maybe just tell us, what that brings to the table? And would you expect to be active in the M&A market? There's obviously -- there's a lot of kind of smaller startups out there that are going after some of those markets. I'm just curious kind of how you're approaching that market -- you're thinking about that the next couple of years?
Yes. So going back to the digital acquisition, it's absolutely a very strategic acquisition for us. What we acquired is the downhole technology, gauge technology, which is integral part of our artificial lift. So this provides the important information on the downhole pressure temperature, that helps us continue to provide monitoring and optimization capabilities to our customers. So this is -- if you kind of think of this as a vertical integration of our optimization solutions. With respect to M&A activity, yes, we always look at through the lens of our top-box performance, number one. And number two, given our capital priorities, and clearly we are focused on deleveraging our balance sheet, so we always make that as -- keep that as a priority. And then we are balancing that with smaller acquisitions, as we have communicated before, which are mostly tend to be technological and geographical in nature for us. And you should expect us to continue to do that, balancing that with the deleveraging the balance sheet.
Next question is from Ian MacPherson of Simmons.
I wanted to ask about the pricing dynamics across both sides of your business. I know that on Drilling Technologies, you have a very strong and rational market structure there, and I would not expect that you succumb to pricing or significant pricing pressure there. Just maybe a comment on that side. But then on PAT, I think when we have talked about this before, it's generally been, yes, the [ refrain ] has been, yes, there is perennial pricing pressure on our products, we transcend those with our productivity gains and innovation, and you see that in the margins. I wanted to get a status check on that narrative as well. But also ask you if pricing pressure has accelerated, given the collapse in activity since September?
Yes. So on the drilling side, yes, we -- pricing is not a major issue right now. And what we are seeing, we expressed in the Q2 call is customers wanting to think about mid-tier cutter usage. And for us, that's not a lot of margin difference between them, the 2 product lines.
On the PAT, I would say that the pricing side is not meaningful right now because I think there is a recognition that there's quite a bit of pricing concessions that played out in the market. And I think the capital discipline, generally the oilfield service companies are talking about, are also been very constructive in that regard. So I wouldn't say pricing pressure is accelerated or anything. It's just -- it's been sequentially pretty much flat, I would say. There is no increased pricing pressure.
That's helpful, Soma. And then, Jay, I was wondering if I could get a comment on your expectations for working capital in the fourth quarter, given the drawdown in the -- in your business. And if there's any either directional or specific comments you might have on that side?
Sure, Ian. We had a good quarter in Q3 in terms of managing down the receivables and drawing down inventory due to the lower activity levels and we expect to continue that momentum into Q4. It may not be quite as strong as we achieved in Q3, but we do expect to continue our efforts around receivable collections, even in the tougher collection environment these days because of capital discipline and then managing the inventory requirements for today's activity levels. So we expect to manage through some working capital contribution and cash flow in Q4.
Our next question from Chase Mulvehill of Bank of America.
I guess, first, just kind of stick on Drilling Technologies. And we think about your margins here, what happened in the third quarter, they came in below what we were expecting. But could you maybe just talk about the impact on margin and split that between absorption and pricing? You talked about taking some cost out towards the end of the quarter. So just trying to understand the impact of both of those on margins in the third quarter.
Yes. I think when you think about the third quarter, the steep decline contributed to a bigger decrementals. And we tend to preserve the capabilities around the technology investments, we tend to preserve capabilities around -- and capacity management so that we can respond quicker because as I've described, we expect a sharper recovery. And so we want to be in a position to be able to respond to that as well. So for us, I think the bigger decrements are mostly driven by the lower volume. Jay, do you have any other color to that?
Yes. Chase, the pace of deterioration that Soma talked about coming out of Q2 into Q3 where we expected continued destocking and expected that to end near the end of Q3, we saw actually quite the opposite where the volume coming out of the quarter was a significant step down as destocking continued through September. And so we believe that we'll see a further impact of that in Q4 but hopefully, we're coming closer to end of that now.
And that's the reason that we decided to update in December is because -- it's not because that we are worried about something, it's more because of the uncertainty around the destocking when it's going to end. And we have seen some slight improvement in order rates in our Drilling Technologies business compared to how we exited September to the first couple of weeks into October. Now we are not trying to say that, that's a trend which we -- it's only 2 weeks. But that's how it starts some times, right? So that's the reason we wanted to make sure that -- in periods of uncertainty, we always believe -- internally we increase our communications. And so we want to do the same externally as well. So we will see how the trend continues.
Okay. All right. Appreciate the color. Just one quick follow-up. If we think about E&P capital discipline and kind of the impact that it's having on Production & Automation, are you seeing any changes on how E&Ps optimize lift and digital solution, given that there is such an intense focus on capital discipline and returns these days?
Yes. The conversations are starting to increase around our digital solutions, and we are encouraged by that. We are doing a lot more proof of concepts with our customers, so we are definitely seeing that.
And the other aspect we are seeing, we are also seeing that even on our midstream customers, that the proof of concepts continuously going up. So -- but what is interesting is also that the proof of concepts also take -- they take a longer time than we've originally thought. Customers want to try it for 5, 6 months before they make a solution on it. The good news is all of these proof of concepts we are doing, they are all paid. So which means -- that indicates the customers are serious about it, they are willing to invest in these tests and tryouts. So yes, absolutely, we are seeing increased conversations on it.
And our next question from J.B. Lowe of Citi.
So looking forward to the mid-quarter update in December, but wanted to ask you real quick about 2020. Let's say that Jay is right and E&P spending in the U.S. is down, let's say, high single digits. But then when you layer in your international growth, your digital expansion, maybe some bit restocking in Q1, maybe just taking some shares with the IOCs, what do you think 2020 top line growth could look like in that environment? And then when you add in your $20 million in annualized cost savings, what do you think incrementals could be in that scenario?
Well, we are not going to give a guidance on 2020 at this point, right? But directionally, let me tell you. So in our PAT segment, right, because of the growth initiatives and because of the efforts we are doing, we should do better than the market. And I think we feel good about that, we continued to demonstrate that, even throughout this year we have demonstrated that. So you should expect that. And on the Drilling Technologies side, I think from -- sequentially from current levels of activity, you should definitely see meaningful improvement. And as we've shown the historical patterns, we should see that. Outside of that, I think in our bearings product line, I think we will definitely see improvements from current levels as we go into the next year. We should see that. So that's probably as much color I would like to give right now regarding 2020.
Okay. That's fine. Just a quick follow-up on the investment you guys made in Argentina. Was this more of a capacity investment? Or more of like the cost-out program, to try to lower cost on the manufacturing side? Just a little bit more color that would be helpful.
Yes. It's more investment to produce things locally for the South American market. So it's more a growth-orientated investment.
And our next question is from Martin Malloy of Johnson Rice.
I just wanted to ask about the cost reduction initiatives, the $20 million annualized benefit. When will that be fully realized? And can you give us a little more detail on what was in that?
Yes. So -- I mean the way to think about it, Marty, is, obviously, in any of these type of annualized savings, there is an element of structural savings and some variable savings, right, related to volume. So roughly, I would mention that about 50% of the $20 million is related to structural-type savings. And then the remaining 50% is more related to the variable volume type savings, which you would expect may return as the volume returns. So that's how I would think about it.
And in terms of just on that $10 million of the $20 million, most of that actions have been completed as we speak. There are few in and outs that are still left, but most of that actions have been completed as we speak.
Okay. And then my second question and this relates to adding new customers on the ESP side, but maybe could you give us an update in terms of the conversion of customers that use your ESPs to using the Rod Lift equipment? And maybe how that's trending as you add new customers?
Yes. So as we have said before, the customers don't buy artificial lift as a full life cycle. So which means just because you have the ESP installations, doesn't automatically guarantee the Rod Lift conversion to it. But since every one of the ESPs we install goes on our monitoring platforms, we have a better insights around and constantly providing consultations to our customers on the right time to convert it. So like we have said in the past, 2 out of 3 times, we tend to be successful getting the Rod Lift conversion associated with our ESPs.
And our next question is from Marc Bianchi of Cowen.
I'd like to follow up on the cost cutting first that we just discussed. Soma, you mentioned that pretty much all of the fixed portion has been implemented. Did you actually realize that as well in the third quarter?
No, not in the third quarter. Yes.
Okay. So we should expect it to...
Mostly towards the end of September because September is when we saw the significant weakness set in. And so this is mostly in the September, beginning October-type actions. Yes.
Okay. So the anticipation is you get a full quarter of it in the fourth quarter then?
Yes. Probably 2 months of it, yes.
Okay. The reason I'm asking the question is, if I'm doing some of the maths on the guidance here, kind of the midpoint of the revenue guide and the midpoint of the EBITDA guide still imply pretty hefty decremental margins in the fourth quarter. And I would think that the tailwind of costs saved there would offset some of that. Could you perhaps provide some more commentary there?
Yes. So the high decrementals sequentially are related to few things. And let me talk about the ones that impact and then what could potentially offset. So the things that impact are typically, as I mentioned to you, the sequential decline in Drilling Technologies, which we have built into our guidance and it definitely impacts that, right, because of what we are trying to preserve for being able to respond. The second aspect of that is the lower manufacturing absorption, which I mentioned, during holiday periods, that would definitely -- and we see that, every year, we see that. So that also impacts that. And then the higher productivity we saw in third quarter in our Production & Automation Technologies, we are not planning that to repeat. So when you think about sequential, that has an impact as well. Now we are evaluating additional actions as we continue to work through our restructuring. So that's what potentially offset the higher decrementals we have planned into the guidance. So that's a possibility. I mean we are focused on lowering that, but that's not how we build the guidance right now. So that could be a potential to that.
And then the last piece, I would say is, I think Jay mentioned, if you recall, he mentioned that we have built -- we have also built in $1 million of legal cost to defend our intellectual property. And this relates to our Drilling Technologies business. And so that also impacts. So in this period, I mean the Drilling Technologies is the highest decremental issue normally because of -- as we are preserving those technical capabilities and resources.
Okay. That's very helpful. Perhaps on the revenue side, if you could talk a little bit about the -- what's expected for the segments in the fourth quarter? I would suspect that drilling tech has the larger decline, and I think you've already called out kind of the $5 million headwind from destocking. I would presume that maybe we're talking about low double-digit declines in revenue for drilling tech, which would imply production is maybe mid- to low single digits on the revenue side in the fourth quarter. Is that how you guys see it?
Jay, you want to answer that? Yes.
Yes. So as you pointed out, Marc, we've already called the $5 million additional decremental from destocking. And then also there will be a continued impact of bearings pushout as some of the oilfield service customers just can't take those bearings deliveries because their capital constraint on downhole tool development. So it will be higher than the low double digits that you just quoted for Drilling Technologies. And then for the...
A little bit higher than that.
A little bit higher, yes. For the reason Soma mentioned was, weather and the holiday schedule and the number of shipping days in Q4, there'll also be a sequential decline in artificial lift.
Okay. That's great. And then my last question just relates to the sort of restocking that you would anticipate in the beginning of '20. Does that occur -- or what might be the magnitude of the rig count? It's just dead flat from here. Because I think there's some anticipation from investors that maybe there really isn't a recovery and maybe it's not like prior periods, but just maybe more normalization of sort of the required level of demand for inserts.
Yes. I would say based on what we are seeing and what we are hearing from our customers, the current level is not sustainable. The level of destocking, how deep they have gone, right? So that's not sustainable. So coming out of it, I would expect that even if the rig count is flat, in the past, the first quarter right out of deeper destocking had been in the 18% to 20% sequential increase. And if you look at the quarter following that, it's been higher than the 18% to 20%. But that is because of the -- as the rig count starts climbing up. They -- so if you think of rig count being flat, you can kind of think about how that can work. I'm not going to put a number right now. But it's definitely going to be in double digits.
And this concludes our question-and-answer session. And we now turn the call back to Soma for closing remarks.
Thank you. Again, I want to thank all of our employees for their continued hard work during this challenging time. And thanks again for everyone for your continued interest in Apergy, and we look forward to talking to you on the fourth quarter earnings call. Thank you.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.