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Apergy Corporation (APY)
Q3Â 2018 Earnings Conference Call
Oct. 31, 2018, 9:30 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning and welcome to Apergy Corporation's Third Quarter 2018 Conference Call. Your host for this morning's call is David Skipper, Vice President and Treasurer at Apergy.
I'll now turn the call over to Mr. Skipper. You may begin.
David Skipper -- Vice President and Treasurer
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. Yesterday, Apergy released its results for the third quarter of 2018. If you have not received a copy, you can find that information on the Company's website at www.investors.apergy.com, including the slides referred to in today's call.
During today's call, Soma will discuss Apergy's third quarter highlights and strategy; Jay will then discuss our third quarter results in more detail and he will be referring to the slides posted on our website. He will then turn the call back to Soma to discuss our growth initiatives and market outlook. And then we will open the call for Q&A.
I want to remind listeners that the news release issued yesterday by Apergy, the Company's prepared remarks on this conference call and the related question-and-answer session include forward-looking statements. These forward-looking statements include projections and expectations of the Company's performance and represent the Company's current views and beliefs. Various factors could cause results to differ materially from those projected in the forward-looking statements. Information concerning risk factors that could affect the Company's performance and other unforeseen challenges and uncertainties could cause actual results to differ materially from those in the forward-looking statements, can be found in the Company's press release as well as in Apergy's registration statement on Form 10 and notes set forth from time to time in Apergy's filings with the Securities and Exchange Commission, which are currently available at www.apergy.com. Except as required by law, the Company expressly disclaims any intention or obligation to revise or update any forward-looking statements.
And in addition, our discussion today will include non-GAAP financial measures. For reconciliations of our non-GAAP financial measures to our GAAP results, please see yesterday's press release and our Form 8-K furnished to the Securities and Exchange Commission.
I will now turn the call over to Soma to discuss Apergy's third quarter results.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Thank you, David. Good morning, everyone. I'm pleased to report that we posted another solid quarter, and we are delivering strong results as a stand-alone publicly traded company. We executed well in the quarter and continued to achieve key milestones and made solid progress on our growth initiatives. From maintaining our technological molten polycrystalline diamond cutters to driving market share gains in ESP, to developing and delivering technology with impact with our digital products, Apergy is performing well. Our teams continue to remain focused on supporting our customers and delivering a differentiated performance.
Turning now to our financial results from the third quarter, revenues increased by $58 million, up 22% year-over-year. Our revenue growth was driven by solid results in both of our operating segments.Consolidated adjusted EBITDA increased by 34% year-over-year, reflecting strong execution and operating performance in both of our segments. As a result, consolidated adjusted EBITDA margin increased to 25% from 23% in the third quarter of 2017. Additionally, we paid down $20 million of debt in the quarter, which demonstrates our commitment to our capital allocation priority. Both of our segments performed very well in the third quarter.
In our Production & Automation technology segment, we posted strong growth, both in our artificial lift product line and our digital portfolio. All of our artificial lift product lines posted growth with ESP posting another strong growth performance. We continue to benefit from our full suite of artificial lift products which enables us to provide the right technology to our customers to efficiently produce at every stage of the wells' lifecycle. This capability helps us to produce revenues throughout the life of the wells.
Digital products recorded significant growth at 46% year-over-year, driven by strong market activity and increasing adoption of our new products. Growth in our digital portfolio was broad-based in Q3 led by downhole monitoring product.
In Drilling Technologies, revenue increased 27% year-over-year, significantly outpacing the year-over-year worldwide rig count increase of 8%. This outperformance was driven by market share gains in polycrystalline diamond cutters and continued adoption of our diamond bearing technology. We continue to advance our shaped cutter technology. The strong results in our diamond cutter business is driven by our teams collaboratively working with our drill bit customers to solve difficult drilling problems and achieve lower cost per foot of drilling.
International activity continues to improve. We are seeing improved activity in Latin America, particularly Argentina and Colombia, where we are continuing to gain traction. Rod lift activity continues to improve in Middle East, however, pricing environment continues to be challenging. Improvement in activity in Australia is driven by growth in our progressive cavity pump and rod lift product lines.
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 recap our operating philosophy and culture. Our operating philosophy is built on three simple tenants. First, we always be relentless advocates for our customers. If our customers win, we win too. Second, we develop and deploy technology with impact that drives, safety, efficiency, and productivity. And third, we are driven to improve with a culture of continuous improvement.
Our strategy and the work we do are highly focused around providing products and technology that drives our customer success. This customer-centric strategy allows for decision making that is closer to the customer and guides our operating philosophy. We believe focus, speed, quality, service and customer-driven innovation are clearly the differentiators that set Apergy apart.
At the heart of Apergy, is a highly motivated team of over 3,200 employees around the world that are focused on a collaborative approach to solving problems for our customers. We have a deeply rooted cultural foundation and we are driven to help our customers succeed. We clearly view our culture as a competitive advantage.
I want to share with you a recent proof point of our customer-centric culture. Frost & Sullivan, a global consulting & market research firm recently recognized Apergy with the 2018 Global Customer Value Leadership Award. Each year, Frost & Sullivan, based on their independent research presents this award to the company that demonstrates excellence in implementing strategies that proactively create value for its customers with the focus on improving the return on investment that customers making its products or services. We believe this award is recognition of the success of our customer-centric strategy.
Now, let me turn the call over to Jay.
Jay Nutt -- Senior Vice President and Chief Financial Officer
Thanks, Soma. As David mentioned earlier, I'll be referring to the slides posted on our website. Beginning with Slide 4, Apergy maintains the momentum that was built coming out of the first half of the year and achieved another solid quarter of operational results. Revenue was $316 million for the third quarter, an increase of $58 million or 22% compared to the third quarter of 2017 performance and an increase of $11 million or 3% sequentially.
Year-over-year revenue growth in the US was $53 million or 27% and non-US revenue growth was $5 million or 8%. Adjusted diluted EPS was up $0.11 or 42% year-over-year to $0.37 as both of our segments continued to perform well in the current operating environment.
Cash flow in the quarter was lower than we achieved during the second quarter as we experienced a build in customer receivables late in the third quarter. As a result, we had a lower adjusted EBITDA conversion to cash from operating activities, less capital expenditures in the third quarter. We view this as a temporary challenge as we are already experiencing stronger collections during October and we're working with our customers to reduce outstanding balances and ensure more consistent and sustainable cash inflow going forward.
Turning to Slide 5, from a macro viewpoint, the longer-term industry fundamentals continue to be favorable for our businesses. Oil and gas prices have demonstrated some choppiness in response to geopolitical headlines and the typical variability caused by changes in supply and demand estimates but commodity prices have maintained a steady upward improvement throughout 2018. Likewise, worldwide rig count is still expanding up 8% year-to-date compared to the full year 2017 average worldwide rig count. And finally, global E&P spending is continuing to grow with increased spending in the United States, which is good for Apergy. Accordingly, we believe we are well positioned to take advantage of the favorable long-term market conditions and we're determined to capitalize upon opportunities with our customers in both of our reporting segments.
Moving to Slide 6, and looking at consolidated third quarter performance, net income in the quarter was $25 million and diluted earnings per share were $0.33. After adjusting for the impact of spin-off related items in restructuring and other related expenses in the quarter, adjusted net income was $29 million or $0.37 per diluted share in the quarter.
We generated adjusted EBITDA of $78 million during the third quarter compared to $58 million in the third quarter of 2017. Sequentially, adjusted EBITDA improved $2 million on the $11 million revenue increase. As a reminder, second quarter adjusted EBITDA benefited by approximately $2 million, driven by lower expenses associated with Dover's continued ownership of Apergy through May 8th. During the third quarter, our businesses continued to capitalize upon favorable market conditions and drove the improved profitability.
In the third quarter, net interest expense was $11 million, which was up sequentially from the second quarter. Once again, the previous quarter benefited from only a partial quarter of interest expense due to the timing of the spin-off. Our effective tax rate in the third quarter was 23%. Cash flow from operating activities in the third quarter was $34 million and as noted earlier, was negatively affected by the late quarter build in accounts receivable. As a result of the lower cash flow from operating activities, our adjusted EBITDA conversion to cash from operating activities, less capital expenditures was 25% in the quarter. This is below our typical levels and viewed as temporary.
Capital expenditures in the third quarter of 2018 were just under $15 million compared to $17 million in the second quarter of 2018. Spending was in line with expectations as we execute on our internal investment plan for the year, including ongoing investments in organic growth and spending on our leased asset portfolio in support of further profitable ESP market penetration.
Jumping ahead to Slide 7. Production & Automation Technologies revenue came in strong at $241 million in the third quarter, an increase of $42 million or 21% from $200 million in the third quarter of 2017 and flat with second quarter 2018 performance. The year-over-year improvement was due to continued growth from our artificial lift offering and in particular, further penetration of the US onshore ESP market. Additionally, we experienced robust revenue growth from our digital products portfolio and capitalized upon improving international market conditions which are supported by the higher current oil prices and activity levels compared to prior year.
Adjusted segment EBITDA rose 41% to $52 million in the third quarter from $37 million in the year ago period, driven by substantial revenue growth. Adjusted segment EBITDA declined slightly from $54 million in the second quarter of this year. The sequential decline in adjusted segment EBITDA was primarily due to the expected increases in material input cost and the anticipated higher corporate cost, combined with increased investments in support of our growth initiatives around our ESP and digital technologies offerings, along with some non-recurring operational expenses.
Adjusted segment EBITDA margin was 21% in the current quarter compared to 18% in the third quarter of 2017 and 23% in the second quarter of 2018. Our year-over-year margin improvement reflects continued cost discipline and solid operational leverage on the increased volume.
Our Production & Automation Technologies businesses continued to have a healthy book-to-bill ratio at 1.0 times compared to 1.05 times in the third quarter of last year and 1.04 times during the second quarter of this year. Book-to-bill will fluctuate from quarter to quarter and we consider the current performance consistent with usual patterns.
Moving to Slide 8. Drilling Technologies posted robust revenue growth of $75 million in the third quarter, representing an increase of $16 million or 27% from $59 million in the third quarter of last year. The revenue growth was a result of higher year-over-year worldwide rig count levels compared to the prior year, which is primarily led by growth in the US rig count, combined with increased market share in the premium diamond cutter market and very strong growth in time and variance for drilling tools.
Compared to the second quarter of 2018, Drilling Technologies revenue increased 15% from $65 million. The sequential revenue increase was again due to increased rig count, driven largely by the seasonal recovery in Canada. The benefit of diamond bearings adoption also contributed nicely on a sequential basis.
Adjusted segment EBITDA increased 24% to $29 million in the current quarter from $23 million in the third quarter of 2017, primarily driven by the higher volumes. Sequentially, adjusted segment EBITDA increased 20% from $24 million in the second quarter, again, driven by higher volume with good earnings conversion and inclusive of the impact of higher allocated corporate cost.
Adjusted segment EBITDA margin was 38% in the third quarter of 2018, compared to 40% in the third quarter of 2017% and 37% in the second quarter of 2018. The slightly lower year-over-year adjusted segment EBITDA margin was primarily due to increased expenses required to scale up and support the growth of our diamond bearings offerings. In the quarter, our Drilling Technologies business continues to have a good book-to-bill ratio at 1.01 times, which is consistent with our expectations. The quarter-end ratio compares to 0.095 times in the third quarter of 2017 and 1.08 times in the second quarter of this year due to stronger bearings orders.
Moving to Slide 9. On the balance sheet, third quarter ending debt, net of debt discount and deferred financing cost was $688 million. Cash at the end of the quarter was $18 million. During the quarter, we made a payment to Dover Corporation of approximately $12 million related to tax liabilities associated with the spin-off transaction. We will have one additional payment to Dover associated with tax liabilities occurring a bit later in the fourth quarter.
In addition, as noted in our earnings release and Soma's prepared remarks, we repaid $20 million of debt on our term loan, consistent with our commitment to our capital allocation priorities, which include funding organic CapEx needs as well as reducing our leverage through earnings growth and debt reduction. At September 30, Apergy's total leverage ratio was 2.6 times and our available liquidity was $263 million.
In the third quarter, adjusted working capital, which is composed of accounts receivable, plus inventory, less accounts payable increased $32 million. As I noted earlier, the increase was primarily related to the slow payment by a few large customers and we are actively working with these customers to ensure timely payment. We do not expect any credit issues with these customers.
Turning to Slide 10. I'll take a moment to discuss our financial outlook for the remainder of the year. Based upon our strong year-to-date performance through September, combined with a positive start to the fourth quarter through October, we are increasing our full-year 2018 revenue growth guidance to approximately 20% year-over-year. We are also increasing our full-year 2018 adjusted EBITDA projection to be in a range of $289 million to $294 million, up from our previous estimate of $280 million.
Our adjusted EBITDA outlook reflects our current view of the market and takes into account, the potential impact of further material and input cost inflation, including tariffs, the risk of E&P capital, budget exhaustion and fewer working days in the fourth quarter. We've now substantially built out our corporate infrastructure and we're on track to exit transition services agreement during the fourth quarter. Our activity in the associated cost around these initiatives are embedded in our earnings outlook. With regard to other factors pertaining to our outlook, our tax rate is expected to be lower in the fourth quarter due to a one-time tax benefit that was recently achieved. Our full year tax rate should be between 23% and 24%.
We anticipate interest expense of just over $10 million per quarter. Our full year 2018 capital spending forecast continues to be approximately 3% of revenue for infrastructure related growth and maintenance, plus an additional $25 million to $30 million for capital investment directed at expanding our portfolio of ESP leased assets.
I'm now going to turn the call back over to Soma for some closing comments, before we open the lines for Q&A.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Thank you, Jay. We delivered another solid quarter and our portfolio and technology are well positioned to take advantage of the positive trends in the market. Our strong portfolio combined with our rigor and execution and cost discipline will help us deliver a differentiated performance in the industry.
Before we open the call to questions, I would like to update you on our progress on the key growth initiatives for 2018 and beyond. Our first growth initiative is on our ESP product line where we are driving significant growth and share gains by continued penetration of the US onshore ESP market. We again achieved solid growth in the third quarter and our ESP product line continues to be our fastest growing artificial lift technology.
Our strong product offering, industry-leading service and established relationship with customers is continuing to help us achieve deeper penetration in the market. We believe we continue to have a sustainable momentum in this business.
Our second growth initiative is focused on existing well conversions to rod lift as production declines. While it is hard to predict the precise timing, we are involved in increasing conversations and orders for rod lift conversion solutions. We are delivering these conversions to rod lift both from ESP and gas lift wells. Our rod lift revenues have grown sequentially every quarter since the beginning of this year. We continue to believe that conversions to rod lift will accelerate in 2019 and beyond. Rod lift remains the artificial lift technology of choice for low flow wells. We are a market leader in rod lift and we believe we are well positioned to capture the growth that will come as a result of the conversions.
Our third growth initiative involves driving significant growth of our digital product revenues. We are increasing adoption of our digital products and services through our fit-for-purpose solutions designed to improve customer productivity and operational economics. We are continuing to invest in developing cost effective Smart Edge hardware and software with improved analytics and optimization capability. Customers are increasingly interested in fit-for-purpose digital solutions that gives them higher granularity of downhole conditions, asset performance, failure prediction and analysis and optimization opportunities.
Our investments and efforts are aligned around these areas. We are well positioned to benefit from continued digital adoption, given our deep domain expertise and strong presence in the production well site. Adoption of our technology combined with strong market activity resulted in 46% increase in year-over-year revenues in the third quarter. We expect to deliver continued strong growth in our digital product lines.
Our fourth growth initiative is the continued innovation and advancement of our technology in our polycrystalline diamond cutters to improve drilling productivity. To that end, our Drilling Technology segment has had 42 new patents issued in 2018 so far bringing the total issued patents, since the beginning of 2008 to 715. We are continuing to advance our shaped cutter technology. We believe there is a strong trend toward shaping and customization of cutters to meet specific drilling requirements. And we are at the forefront of this trend working closely with our drill bit customers. Customer adoption continues to remain strong for our new technology and this resulted in 51% of our revenues in the segment in the third quarter coming from new products.
Our final growth initiative is focused on driving continued adoption of our diamond bearings in downhole applications including rotary steerable, mud motors and power generators. Compared to traditional bearings, diamond bearings provide higher load capability, significantly longer life and lower repair costs. On a year-over-year basis, revenue from our diamond bearings was up over 63% in the third quarter. In the third quarter revenues from diamond bearings business represented about 12% of our Drilling Technologies revenue. We are investing to expand our capacity to meet the strong demand. We expect the strong revenue growth in diamond bearings to continue as there is more adoption runway in downhole applications and other applications where this technology can be applied.
We expect to finish 2018 on a strong note. We remain focused on our customers, strong execution, productivity improvements and cost discipline. While the industry is seeing some slowdown in completion, our portfolio is not directly exposed to completions. We continue to keep our attention on what we can control and on delivering a solid performance relative to the industry.
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 accomplishment and it is a privilege for me to lead such a great team.
With that, I would like to open the call for questions.
Questions and Answers:
Operator
Thank you. We will now begin the question-and-answer session. (Operator Instructions) We have a question from Dave Anderson from Barclays.
David Anderson -- Barclays -- Analyst
Hey, good morning, Soma. I was wondering if you could talk a little bit about the competitive dynamics you're facing right now in artificial lift. Artificial just come up in a number of prior calls. I'm just wondering if you could talk about, kind of maybe what you're seeing out there in the Permian and kind of how that differs from the other basins? And also kind of in particular, what's the differentiation that you are offering versus your competitor? You talked about gaining share. I'm just wondering if you could just kind of, plus dig into that a little bit more, in terms of those dynamics.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yeah. Hey, good morning, Dave. So, great question. So I want to kind of give a little bit color on artificial lift like you pointed out. So if you look at -- if you segment the market as US or North America versus international, the dynamics are somewhat different. So in US market, we are continuing to see activity improving. In fact, we recorded in US a sequential gain in artificial lift of about 2% from Q2 to Q3, and then year-over-year, our artificial lift growth was over 23% as a total. International tends to be a little bit more lumpy for us because it tends to be more tender driven, so it tends to be more lumpy for us. So if you look at what's happening with the basin, I also want to remind that if you recall during our Q2 call and thus in subsequent in public conferences, we had mentioned our deliberate attempt to make sure that we're being prudent about capital deployment into our leased assets. If you recall, we've said, we have more demand than we can carry. So we actually did reduce our capital deployment in leased assets given some of the industry uncertainty around completions and all that. So we could have grown more sequentially in artificial lift, but it was purposeful.
In terms of competitive dynamics, the key to artificial lift as we talked about, the two large technologies which remains ESP and rod lift. In ESP, particularly in the onshore ESP, it still continues to be -- the winning companies tend to have very strong service, a good portfolio of product offering and ability to apply and size the right pump along with superior control technology for the ESP. So service and application know-how continues to be the key. And the way we share gain -- gain share in the marketplace is primarily through that in ESP. Now when it comes to rod lift, rod lift tends to be more of around because -- as customers go the rod lift, they tend to stay on rod lift for a long period of time, it could be 10 years, 20 years, in some cases even 30 years. So they tend to choose technology and brands that have a proven track record of success. So, having the best brands in the industry with Harbison-Fischer, and Norris Rods really helps us in that regard. So the competition in the -- is continuing to be strong in the marketplace but we focus on what we can control. And being a pure play, full suite artificial lift player, it really helps us to be fast at the same time provide the right service and right response.
David Anderson -- Barclays -- Analyst
So Soma, on your guide for this year, you raised your full year guidance, but you've got a lot of push back throughout the year, as Permian issues have sort of come in, a lot of people have been pushback and say " Hey ESPs probably has to get pushed down. Even insistent, you haven't seen any changes from your customer behavior, can you talk about that now? Are you still kind of seeing the same thing that you still feel confident that kind of that the demand is still there for these products, and your customers, are they looking past these takeaway issues?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yeah, when you look at the -- with respect to particularly ESP, I think the two questions that have come up is about possibly completion slowdown and possibly gas lift. So let us both. As we just mentioned, as Jay mentioned in the prepared remarks, October has started off well for us. So again, we have not seen any demand decline in October. So the Q4 started off well for us. In terms of, with respect to the gas lift, as I mentioned in previous calls, they both are relevant technologies but Permian is a large region and each of them tend to be very distinct in their own way whether they apply ESP or gas lift. So both will be a relevant technology. So if you look at, for example, if it is a high water content well, they tend to use more ESP, but if that is a high gas content, then they tend to go a little bit more with gas lift and there is also other things that drives the requirement of gas lift if they have a gas infrastructure, compression capabilities available and so on and so forth. So being a full suite provider, we have the ability to offer what is the right solution for the customer, Dave, and we really haven't seen, the ESP demand for a slowdown and be on a very solid growth in Q3. And Q4 have started off well and we actually have authorized some additional capital to be deployed in the leased asset, which will continue to help us. As you know we pulled back a little bit in -- so now we have authorized some additional capital, which will help us as we go in to -- continue into Q4 and into 2019 as well.
David Anderson -- Barclays -- Analyst
Last question from me, it seems like it's a buyer's market out there for M&A, right now, I'm sure you again pitched on a host of things. Can you just kind of help us understand what makes sense for Apergy -- what are the things, as they're sort of coming over to transform here, what makes more sense for you? What are the types of assets that makes sense? Can you just kind of walk us through your thoughts or what you can say?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yeah, so I think, look, as we communicated as a capital allocation priority, we want to fund the organic growth initiatives, we want to make sure we are continuing our innovation investments, we want to make sure that we are looking at as an M&A opportunity in the near term a more tuck-in type acquisitions which either improves our technology position or a geographic position or a cost position. And we have more also very focused on making sure that we get our leverage down, which you saw, we paid $20 million toward that. So you will see us continuing to follow this process. There are large opportunities that keep coming up, but we are very focused on sticking to our discipline of capital allocation and we want to get our leverage down. As we've communicated, we have comfortable to commit between 1 and 2 as we said before.
Now as we've finished our leverage down, you asked the question Dave, what kind of assets that would be of interest to us. As we think about those, the things which will be of interest to us is the ones which are consistent with the quality of our portfolio, and what I mean by that is, products or service that performs well through the cycle, because if you look at our portfolio, one of the key characteristics of our portfolio is, it performs well through the cycle. So we want to make sure any product or service line we add to our portfolio is consistent and does not dilute the quality of our portfolio. So that is number one. And number two, the type of company we would want to consider would be companies that have a consistent cultural behavior like ours which is a very customer centric type of culture. So that kind of gives you a little bit of flavor of the type of companies, we would look for, once we get our leverage down.
David Anderson -- Barclays -- Analyst
Okay. Thanks, Soma.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Great.
Operator
The next question comes from Byron Pope from Tudor, Pickering.
Byron Pope -- Tudor, Pickering, Holt -- Analyst
Good morning, guys.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Good morning Byron.
Jay Nutt -- Senior Vice President and Chief Financial Officer
Good morning Byron.
Byron Pope -- Tudor, Pickering, Holt -- Analyst
I just have a question, as I think about the implied EBITDA guidance for Q4, and could you just -- based on what you've said so far in the call, it sounds as though the guidance range is really a function of laying out some risks that could happen as opposed to what you've seen to start the fourth quarter. But as I think about drilling technologies versus Production & Automation Technologies, can you frame for us, what's essentially implied in your overall guidance with regard to what the top line might do directionally in those two segments?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes. So Byron, so talking about Drilling Technologies, so we expect the drilling activity to be, continue to be stable in Q4. And so which means for our Drilling Technologies, we believe the activity continues to be stable as we walk into Q4 and we have seen that in October. The only time we have seen -- the only thing we -- there could be any -- if there is any impact on Drilling Technologies could be, sometimes the bit plans of our customers, may sometimes shut down for holidays, depending on what their planning process is, which means their ability to receive shipments can get affected either in the last week of the quarter, and we are right now in conversations with customers to better understand who is planning what type of shutdown. But that's more of a function of, if you don't ship it in end of Q4, it could, it will be the beginning of Q1. But it's not, we don't necessarily see a market-related risk to that.
Now, when it comes to Production & Automation, typically what we have -- in our Q4 guidance here, what we have kind of assumed, if look at the range, we have assumed. What's assumed in the range is, if you think about the lower end of the range, that could be because that can happen because there is budget exhaustion that is starting to slow down some spending and particularly more as we approach Thanksgiving and beyond, because the way we have thought about it is, we have seen October start off well, so and we have some clarity into November based on our bookings, but truly, so the risks tends to be more around the Thanksgiving and beyond and how the budget slowdown can happen, and we just don't have a good visibility of it, hence the range.
The second aspect of it is sometimes you see in Permian, in particular or West Texas, you see weather-related issue pop up. We have seen that before. So there could be some weather-related issues that can pop up and particularly that will impact our rod lift, particularly, because most of our rod lift in West Texas is driven by existing wells. So other than that, as I mentioned, October started off well so that's why we thought it's prudent for us to provide a range. So Jay, do you have any other?
Jay Nutt -- Senior Vice President and Chief Financial Officer
You've already commented on them. And the other items that we're watching Byron are continued increases in material input cost, including tariff as we started to see the initial implications of that in Q3 and of course we're offsetting that to the best of our ability with price increases and supplier concessions, as well as our own productivity initiatives. So the ramp up in higher material input costs is something else that we've just -- we've prudently taking accounting for in our guidance.
Byron Pope -- Tudor, Pickering, Holt -- Analyst
Okay. That's really helpful. Then I just have one quick additional question, and I realize these won't be big dollars involved, but just given the demand drivers for your diamond bearings when you use the word, steerable (ph) systems in that motors, it certainly feels as though you are going to continue to see strong demand for those sorts of service lines from your customers that are providing those downhole services. And so with regard to what's involved to increase the capacity on the diamond bearing side, again I realize it's probably not big dollars, but what do you have to do there to increase that capacity to meet the demand growth?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yeah, it's typically investment in manufacturing cell. So this will be CNC machines and type of capacity. So, Jay, you want to give a color on what a manufacturing cell would cost?
Jay Nutt -- Senior Vice President and Chief Financial Officer
Sure. So order of magnitude, it's probably about $1.5 million or more for the machines Byron. We added some capacity that came online early in the third quarter with additional investments that just got installed early in October and we will start to contribute. So that will help us to bring some work in-house, that's currently being outsourced, but the investments are not large with regards to the additional capacity that we put in place.
Byron Pope -- Tudor, Pickering, Holt -- Analyst
Okay. Thanks guys. Really appreciate it.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Thank you, Byron.
Operator
The next question comes from Scott Gruber from Citigroup.
Scott Gruber -- Citigroup -- Analyst
Yes, good morning.
Jay Nutt -- Senior Vice President and Chief Financial Officer
Good morning.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Good morning, Scott.
Scott Gruber -- Citigroup -- Analyst
Jay, just another question on the 4Q outlook and I may have missed it, so I apologize if I did. But will the overhead expense rise further in 4Q as you continue to build out the back office and if so, by how much?
Jay Nutt -- Senior Vice President and Chief Financial Officer
No, Scott. So, we're substantially done with the ramp up, there's a couple of few positions that are being put in place and we are really within a matter of a few days of being done with a transition service agreement. So we made great progress in building up the -- building out the corporate infrastructure in Q3. So you should not expect any material increase in terms of corporate costs from a run rate basis.
Scott Gruber -- Citigroup -- Analyst
Got you. So 64 (ph), 65 (ph) on a run rate basis, excluding the charges that fall off, that's how we should think about it?
Jay Nutt -- Senior Vice President and Chief Financial Officer
So I think you're thinking about just the total SG&A there and I think that's a reasonably good number. We did make some investments within the operations in support of the ESP growth, in SG&A as well as digital offerings. So some of the increase in the quarter is from the ramp-up of the corporate cost plus increases within the operating units themselves in support of the growth initiatives.
Scott Gruber -- Citigroup -- Analyst
Got it. And then just a follow-up to Dave's line of question earlier. Soma, just directionally, do you think production revenues, are they trending higher in the first half of next year? Is the outlook more flattish, does it dip some -- overall the big question we get is, would it be an echo that hits lift sales in the first half of next year, given the current completion slowdown in the US?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Great question, Scott and it's definitely, it's on our mind. So we are busy with our planning process for 2019. So I'm not going to be able to give specifics on that right now, but a couple of things I would say. We definitely expect 2019 to be a growth year for us. So the question of progression through the year is what we are thinking through and doing more work on. I would also say that the relationship -- I mean there is a lag between completions and artificial lift, but the relationship segment completions artificial lift is not quite one to one, as existing wells also require ongoing maintenance and replacement and conversion to another form of lift, right? So it's not quite one to one but it does have an impact, when there is a completion slowdown, there will be some part of impact. The other part which we are also thinking through as we enter into 2019, there is also reloading of customer budget right, right? So that can also customers may accelerate from spending since they have new budgets assigned. So those are the variables we are thinking through. So it's a -- just a question of how the progression is going to be and we will be -- we are not in a position to talk about it now, we'll talk about it more as we enter into the next year.
Scott Gruber -- Citigroup -- Analyst
And it seems like the outlook for the international side of production is improving. Can you just remind us, what percent of the production or sales is outside the US and Canada?
Sivasankaran Somasundaram -- President and Chief Executive Officer
So on Production & Automation Technologies, if you look at Q3, it's roughly about 22%.
Scott Gruber -- Citigroup -- Analyst
Got it. Thanks for the color.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Okay. Thanks Scott.
Operator
The next question comes from Blake Gendron from Wolfe Research.
Blake Gendron -- Wolfe Research -- Analyst
Hey, thanks for taking my question guys. The first one just digging into capital allocation, it seems like organic growth and build out is going to be an ongoing initiative here. But as we think about the deleveraging side of the story, do you have specific targets in mind? Or can you refresh us on those targets, the timing and then as we think about the handoff between deleveraging and potentially shareholder returns, how do you think about those in relation to a dividend versus possible buybacks? Thanks.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yeah, I think what we have communicated on this is, we are comfortable to get it down somewhere between one and two. So if you kind of think about that, say 1.5 as a possible point. I think, we think we may be able to get there by end of 2019 by a combination of our continued EBITDA growth, the earnings growth as well as periodically paying down some of the debt.
Now we have focused on a very balanced capital allocation beyond that, so which means you should expect us to think about a balance between returning cash to the shareholders as well as continuing to invest in our growth. And we are planning to communicate our full value creation framework and algorithm in our Investor Day, which we are planning to hold some time in March. You should receive information about that where we are planning to communicate our full value creation framework along those slides as well. Jay, anything to add?
Jay Nutt -- Senior Vice President and Chief Financial Officer
No, Soma, you've kind of hit it. So again we want to continue to chip away the debt, but not at the expense of investing in the growth of the organization, such as the bearings growth and the ESP growth as well as the other growth initiatives, that Soma talked about that gives us technology or a cost advantage and then excess cash flow in the meantime will be used to repay debt.
Blake Gendron -- Wolfe Research -- Analyst
Okay. Great. Appreciate the color. And then moving to Drilling Technologies, you guys have advantage share in virtually everyday market that you participate on the Drilling Technology side. But if we think about potentially the rig count getting more stable in the US, perhaps growing internationally on land are there regions internationally that you can outgrow the broader rig count, and is that going to be just share gains on the part of PDCs or is that going to rely more so on the organic buildout of technologies within the portfolio?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yeah, I think on the international side, there is still some room for adoption of PDC compared to the regular type 1 type cutters. So I think that opportunity is still there. Beyond that, it will be one of continued innovation and technology as we have talked before. This is that product line where customers always adopt new technology if it is reducing the cost per foot of drilling either by increased rate of penetration or longer-lasting of cutters. So I think but internationally, there is still some runway for increased PDC adoption.
Blake Gendron -- Wolfe Research -- Analyst
Okay. Great. And then finally from me, the vintage of wells that were completed from 2013 to 2014, where are those in the life cycle on artificial lift side and what are the opportunities? I imagine it's mostly rod lift, but just if you don't mind refreshing us on where those wells stand from a lift standpoint?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yeah, so as we said in our prepared remarks about some of the conversions we are starting to see are from the 2013, 2014 wells, is what we are starting to see. And as a reminder, we have -- each customer when they switch to another form of lift is different, within a band of production flow rates. So it's hard to predict exactly at what flow rate every customer and we are doing lot of granular work on understanding customer by customer, at what threshold do they prefer to switch over, but the vintage of wells we are seeing currently are mostly the 2013, 2014 wells.
Blake Gendron -- Wolfe Research -- Analyst
Okay. Great. Thanks. I'll turn it back.
Operator
The next question comes from Marc Bianchi from Cowen.
Marc Bianchi -- Cowen & Co. -- Analyst
Thank you. In the press release and in the commentary you mentioned about the conversion to rod lift and you had some orders to convert from ESP and gas to rod lift, can you talk a little bit more about this, what's the magnitude of the opportunity here that you've seen in these orders? When would that start to show up in the business and how has this changed from prior quarters from what you're seeing?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes, Marc, I think as we talked about in the last quarter call, this is -- the way we think about this conversion is not as if it's one big group of wells suddenly all convert at the same time to the -- because each customer is different. So what we are seeing, as we mentioned in the call is, we are seeing sequentially rod lift getting better and better in revenues. We are seeing that top line growth continuing to grow. And if you look at that year-over-year growth, it's continuing to accelerate since the beginning of the year. Every quarter we have seen increased year-over-year growth on rod lift. And we attribute that to the continued conversion of this but they don't come here is 100 wells, all complete at the same time, the customers do it at their own pace, and so, the way I would describe it, you should expect our rod lift product lines to continue to provide increased growth.
Marc Bianchi -- Cowen & Co. -- Analyst
Okay. Is there -- can you share with us what the mix of rod lift was, in the third quarter?
Sivasankaran Somasundaram -- President and Chief Executive Officer
The mix of rod lift in the third quarter, yeah, I can give that -- Jay, you have that number? Give us 10 seconds.
Jay Nutt -- Senior Vice President and Chief Financial Officer
Above 36% -- above 35%, 36%
Sivasankaran Somasundaram -- President and Chief Executive Officer
36%, yeah.
Marc Bianchi -- Cowen & Co. -- Analyst
36% of Production & Automation?
Jay Nutt -- Senior Vice President and Chief Financial Officer
Yeah.
Marc Bianchi -- Cowen & Co. -- Analyst
Okay and maybe --
Jay Nutt -- Senior Vice President and Chief Financial Officer
It's of artificial lift, Marc.
Marc Bianchi -- Cowen & Co. -- Analyst
Of artificial lift. Okay. Thanks. And the tariff headwind that you have, can you just remind us where you're exposed there? I believe it's mostly on the ESP side. As I understand, there's some increase in tariffs in the beginning of next year. How is that -- how have you prepared for that and what's the potential impact?
Sivasankaran Somasundaram -- President and Chief Executive Officer
So let me make some comments here and see whether Jay has additional color. So just to remind on the tariff impact, again as you know, there are two types of impact. One is the Section 301, which is very specific to China, and then there is the Section 232, which is related to steel, and there is also a secondary impact of that because of US steel mills getting lot of demand placed because of Section 232, there's an impact of price increase because of that. So for us, the Section 301 and again, in the Section 301, everybody is very familiar with the list 1 , list 2, list 3, as you know each time, each list gets effective, depending on vary of product is listed. So for us, Section 301, the primary impact for us on that is the ESP because, as we mentioned our ESP supply chain extends to China.
On the Section 232 related, for us it is more of not a direct 232 impact, but it is the inflation because of US steel mills are running pretty full, and there is inflation associated with it, and that primarily affects our rod lift product line -- the SACROC product line. So I would say Marc, those are the two primary impact related to our material cost inflation. So how we are offsetting that. First, we have put through price increases, and on the price increases, it's getting more traction every quarter. So we implemented it in the middle of Q3. So as we walk into Q4, there is more benefit we are getting from the price increases. And we are -- I also want to point out that we are being strategic about it. So in certain cases where we see and our ability to gain some share or strategically win an account, we may use that lever as well, but price increases we have put in place both in our rod lift as well as our ESP product line and we are starting to see that traction, particularly toward the end of Q3 and also we have started seeing in October.
The other aspect we are doing is our negotiations with suppliers. So supplier, this is concessions from supplier specifically because of the tariff related items. So those two are very specific initiatives to offset that impact of tariff. Now, on top of this, we have our ongoing productivity improvements, which we have talked to you about before. We target on a gross level. Roughly 4% of our cost of goods sold as a productivity improvement efforts and this productivity improvement efforts are not specific only to the tariff issue, but it is also to offset inflation in direct labor and other material type inflations as well. So that's how we are positioned. Now -- today I can tell you, the direct impact of the tariff and material cost inflation and just the price increase and the supplier concession alone is not offsetting yet. They backup that tariff impact. Now what is helping is our productivity improvement. So as our pricing continues to gain traction, we should get better and better help with that. So hopefully that gives you some color.
Marc Bianchi -- Cowen & Co. -- Analyst
Yeah. Okay, that's all very helpful. Thanks so much, Soma. I will turn it back.
Operator
We have Saurabh Pant from Jefferies. Please go ahead.
Saurabh Pant -- Jefferies -- Analyst
Hi guys, good morning.
Jay Nutt -- Senior Vice President and Chief Financial Officer
Good morning.
Saurabh Pant -- Jefferies -- Analyst
Good morning, Saurabh.
So I guess, I would like to focus a little on the artificial lift side of things first. So just to understand, first thing, third quarter numbers, if fells under revenue side right, because revenues were flat and based on the commentary, I think you've said artificial lift was up 2% and I think based on the press release digitally was up like 4%. So it sounds like other production equipment within that, the WindRock and WellMark and Timberline and some of the other product lines were down sequentially, right? So I just wanted to understand what was going on in that small part of the segment?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yeah. So specific to artificial lift, I think what we mentioned sequentially, I think in the commentary, question is very specific to sequential, there are three elements. So the first one is our US portion of the artificial lift grew sequentially 2%, so that is the first comment. So the US grew 2%. Now we could have grown more as I point -- as I mentioned earlier, you remember we earlier communicated that we are tapping the breaks on our capital deployment on leased assets right? So we could have actually grown more in sequentially, but it was purposefully we tap the brakes, just to be prudent about given the uncertainty in Permian takeaway and completion. As I mentioned just now, we have actually authorized more additional capital in October to deploy into our leased assets because we feel comfortable now. So that should give us more benefit in toward the end of Q4 and beyond into 2019 getting ready for 2019.
The third element in artificial lift is our international business tend to be lumpy. And the reason is because they have more tender focussed business for us. And so what happens is, you may have a higher shipment in -- a big shipment in Q2, that may not repeat in Q3. So that tend to provide that. So I just want to say we are seeing the momentum in the artificial lift in our US, we are continuing to see the momentum, we grew 2% sequentially, we could have grown more. So there is no slowdown, we are currently seeing, in the momentum of our artificial lift business, particularly in the US.
Saurabh Pant -- Jefferies -- Analyst
Okay. That makes a lot of sense, right. So I'm just trying to think right, I mean taking that forward right, as it sounds like, at some point in the third quarter, you went to your ESP customers, I'm guessing primarily in the Permian right? Because that's where the leasing model is predominant rate. You went to your customers and I guess you would have told them that look we want to transition more to the upfront sale model versus the leasing model rate right? And it sounds like customers don't want that right? And maybe that's what you saw? And that was a factor in your decision or not?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yeah. That's not actually true. I mean we're seeing increased purchase as well. So there -- both models are being very, very relevant right now. I'm talking about Permian, both models are being very relevant. Yeah.
Saurabh Pant -- Jefferies -- Analyst
Okay. So there is nothing on those lines, right? Okay.
Sivasankaran Somasundaram -- President and Chief Executive Officer
No.
Saurabh Pant -- Jefferies -- Analyst
Okay. And then quickly, going back to rod lift. I think you said 36% of artificial lift was rod lift in the third quarter. And if I remember the Analyst Day presentation correctly, I think that number was 48%, and I think that was the 2017 number. So definitely ESP has grown a lot. But if you can give us some placeholder on a year-over-year basis, what has rod lift done? Right, so three quarter -- 3Q '18 versus 3Q '17, how much is rod lift up, because you did say that it's up?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes, it's up high single digit year-over-year.
Saurabh Pant -- Jefferies -- Analyst
Roughly. Okay.
Sivasankaran Somasundaram -- President and Chief Executive Officer
And it has grown every quarter for us.
Saurabh Pant -- Jefferies -- Analyst
Yes, you said that. Right. You said that. Okay. And then final one for me is on the Digital side. So I did make note of that comment in your press release that you just commercially released your next generation rod lift controller. So as I think about that, right, because you specifically said rod lift, I think that the customers are more price sensitive in that market just because rod lift are much lower volume whereas, right? So there's just enough incremental production to offset that cost of using that new controller, right? So from a pricing standpoint, where does this new products stand versus whatever the prior product was? Is it cheaper than the prior product or this is just a better product?
Sivasankaran Somasundaram -- President and Chief Executive Officer
No, it's definitely cost effective than the prior product.
Saurabh Pant -- Jefferies -- Analyst
Okay. So we should think that it's not just better, but also cost effective. So it would make it a meaningful dent, I guess, that makes it more attractive with the customer?
Sivasankaran Somasundaram -- President and Chief Executive Officer
That's exactly right. Yeah.
Saurabh Pant -- Jefferies -- Analyst
Okay sir. Perfect. Okay guys, I think that's all I had. I'll turn it back. Thank you.
Operator
We have no further questions at this time. I would like to turn the call over to Mr. Skipper, for final remarks.
David Skipper -- Vice President and Treasurer
Again, thanks everyone. Again, I want to extend again our thanks to our employees for a terrific job in executing on a solid quarter for -- in third quarter, and we look forward to talking to you again in the next quarter. Thank you.
Operator
Thank you. Ladies and gentlemen, this concludes today's conference. We thank you for participating. You may now disconnect.
Duration: 67 minutes
Call participants:
David Skipper -- Vice President and Treasurer
Sivasankaran Somasundaram -- President and Chief Executive Officer
Jay Nutt -- Senior Vice President and Chief Financial Officer
David Anderson -- Barclays -- Analyst
Byron Pope -- Tudor, Pickering, Holt -- Analyst
Scott Gruber -- Citigroup -- Analyst
Blake Gendron -- Wolfe Research -- Analyst
Marc Bianchi -- Cowen & Co. -- Analyst
Saurabh Pant -- Jefferies -- Analyst
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