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Apergy Corporation (APY)
Q4Â 2019 Earnings Call
Feb 25, 2020, 10:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning. Welcome to the Apergy Corporation's Full Year and Fourth 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.
David Skipper -- Vice President and Treasurer
Thank you. Good morning, everyone. With me today are 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 full year and fourth quarter highlights, as well as our market outlook. Jay will then discuss our full year and fourth quarter results, and we'll 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's filings with the Securities and Exchange Commission, which are currently [email protected].
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 fourth 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 full year and fourth quarter results.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Thank you, David. Good morning, everyone. I would like to welcome our shareholders, our analysts and our employees to our full year and fourth quarter 2019 earnings call. Thanks for joining the call. The past year has been an eventful and transformative year for Apergy. During 2019, we executed well during a period of changing market conditions and announced a transformational merger with Champion X, which will help to propel our growth and value creation into the next decade. I'm pleased to report that Champion X performed well and met expectations in 2019. Our integration planning with Champion X is well under way and we expect to close our merger with Champion X by end of the second quarter. As we work through our integration planning, we are becoming even more excited about the future we will build with Champion X, including delivering meaningful synergies.
We will be uniquely positioned to offer customers a full suite of production optimization solutions as well as solidifying our position as a focused leader in the production segment, with greater scale, enhanced customer touch points and larger geographic footprint supported by strong cash flow generations through the oil and gas cycle. After closing of the merger, we will have over 8,000 talented employees working collaboratively to solve customer problems around the world. And as the second largest provider of production optimization solutions in the marketplace, we will be an even more valued partner to our customers. On slide s five through seven of the presentation, we have included more details regarding the strategic rationale of the merger, the time line to closing and Champion X's 2019 results.
Additionally, for the second year in a row, we earned the top overall ranking for total customer satisfaction and were ranked first in eight additional categories in the 2020 Oilfield Products & Services Customer Satisfaction Survey conducted by EnergyPoint Research. This independent annual survey is the industry benchmark for measuring customer satisfaction across the global oilfield and is comprised of thousands of in-depth evaluations. We believe these awards validate the success of our strong cultural foundation, our differentiated technology portfolio, as well as our operating philosophy, which is centered on advocating for our customers, delivering technology with impact and driving continuous improvement across our organization. In the survey, Apergy rated first in total satisfaction, artificial lift, digital oilfield, engineering and design, performance and reliability, intelligent sensors and controls, shale-oriented applications, horizontal and directional wealth and high-pressure and high-temperature applications.
Turning to our full year and fourth quarter results, onshore activity levels in the U.S. remains subdued with particular weakness in December, driven by budget exhaustion and capital discipline at E&P operators. Against this backdrop, we continue to maintain our focused execution and strong cost discipline. Excluding $7.7 million of isolated fourth quarter charges in our U.S. artificial lift business related to a customer bankruptcy, fixed asset adjustments and few customer concessions, full year 2019 adjusted EBITDA was $259 million and $52 million in the fourth quarter. I'm pleased that on an operational basis, our business continued to perform well. Excluding isolated charges, our adjusted EBITDA margin was 21% in the fourth quarter and 23% for full year 2019. Additionally, we estimate that the restructuring actions we took at the end of the third quarter resulted in $5 million of savings in the fourth quarter.
As we enter 2020, we expect to build on those savings. Full year international revenues outside of North America were strong in 2019, achieving 12% growth over prior year. With respect to free cash flow generation, we posted outstanding performance on this metric. We converted 10% of our revenue to free cash flow for both the full year and fourth quarter. In 2019, we grew free cash flow 10% more than 2018, representing an incremental $10 million on a dollar basis. We believe our solid free cash flow performance demonstrates the quality of our portfolio, the resiliency of our product lines through the industry cycle and our operating discipline. Consistent with our capital allocation priorities, during 2019, we repaid $105 million of term loan debt, of which $30 million was in the fourth quarter, bringing the total repaid to $150 million since our spin-off in May of 2018. Turning to our segments. In the fourth quarter, Production & Automation Technologies segment revenue decreased 8% sequentially, which was driven by the capital discipline of our U.S. E&P customers.
December was particularly weak as our customers work to keep their 2019 capital spending within cash flow. Although the fourth quarter was challenging for our artificial lift products in the U.S., 2020 has started off well. We have provided a chart of our monthly ESP installation in the presentation on slide 13. As you can see, installation in January were up significantly from December as customers start their new budget year. In the fourth quarter, we continued to perform well internationally. Within our Production & Automation Technologies segment, international revenues were up 3% sequentially, with particular strength in Middle East and Australia. In 2019, our international growth outside of North America in this segment was 8%. For 2020, we continue to expect strong growth outside of North America for our artificial lift and digital product lines as international and national oil companies continue their international development work.
Additionally, after the closing of our merger with Champion X, we will be working to drive additional international growth through a deeper relationship with the international and national oil companies, including cross-selling opportunities for our artificial lift and production chemicals. Fourth quarter digital revenue grew 6% year-over-year and full year 2019 revenue was up 13%. Growth was led by our downhole monitoring products as a significant portion of our digital products are hardware, there may be lumpiness from quarter-to-quarter, particularly during periods of E&P capital discipline. However, over time, we expect our digital revenues to grow at a healthy rate, and I am very pleased at the traction of our digital portfolio is getting in the market. In our ESP product line, we continue to remain disciplined in deploying our leased assets to opportunities that maximize returns. To this effect, in 2020, we will reduce the amount of capital deployed into our leased asset portfolio. We feel prioritizing cash flow and returns over growth is the right decision in a volatile and challenging market environment.
Moving to drilling technologies, consistent with our expectations, auto rates for polycrystalline diamond cutters stabilized and subsequently improved toward the end of the fourth quarter as customers completed their inventory's destocking activities. In the fourth quarter, Drilling Technologies revenue decreased 20% sequentially. The revenue decline was driven by the sharp 11% sequential decline in the average U.S. rig count as well as an estimated $4 million incremental impact from the third quarter due to our customers' destocking their polycrystalline diamond cutter inventories. As we noted in our last earnings call, historically, after we have seen two sequential quarters of revenue decline due to customers' destocking their inventories, in the subsequent quarter, we have seen a rebound in order rates and revenues. Consistent with past experience, we have seen healthy order rates in January and February, and we expect to post sequential revenue growth in the first quarter. Even during periods of significant revenue decline in our Drilling Technologies segment, we continue to maintain our investment in research and development activities, which costs us higher than normal decrementals to adjusted segment EBITDA. We believe that it is important to maintain our technological advantage as well as to continue the development of new non-oil and gas applications, leveraging our diamond sciences knowledge.
During the fourth quarter, 46% of our revenues was from products developed in the last three years, which demonstrates the importance of keeping our technological edge. 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. Consistent with the outlook we provided on our third quarter earnings call, during the first quarter of 2020, we expect activity levels to sequentially improve, driven by new budgets and restocking by our throughput customers as well as continued international growth. Our results in January and February orders, so far, have confirmed this outlook, and we expect to deliver sequential growth in the first quarter. We continue to remain focused on the factors under our control, including advancing our growth initiatives, maintaining a cost discipline, implementing productivity improvements and generating free cash flow.
Additionally, our planned merger with Champion X will open new avenues for growth, augment our earnings through substantial cost synergies and accelerate our strategic goals of broadening our portfolio and geographic footprint, as well as expanding our customer relationship. Overall, we are pleased with our progress on our strategic, operating and financial goals and are well positioned to continue to deliver top box performance through cycles.
Now let me turn the call over to Jay.
Jay A. Nutt -- Senior Vice President and Chief Financial Officer
Good morning, everyone. Thank you for joining our call. As David mentioned, I'll be referring to the slides posted on our website. Beginning with slide eight, for the full year 2019, revenue was $1.1 billion, a decrease of 7%. International revenue was up 12%, while North America revenue was down 10%, driven by the sharp decrease in U.S. rig count in the second half of 2019 and a strong pullback in spending in the fourth quarter by our North American E&P customers as we exercise capital discipline. Consolidated fourth quarter revenue was $248 million compared to the year ago period, revenue decreased $65 million or 21%, and the $248 million in the quarter represented a decrease of $29 million or 11% sequentially. Excluding the effects of acquisitions and divestitures, revenue was down 20% compared to the year ago period. The fourth quarter year-over-year revenue decline in North America was $68 million or 26%, partially offset by international revenue growth of $3 million or 7%.
Full year adjusted EBITDA was $251 million, with fourth quarter adjusted EBITDA of $45 million. Full year and fourth quarter results include charges of approximately $8 million, which are primarily for reserves for bad debt, including the bankruptcy and other customer concessions related to contested billings for an isolated number of artificial lift customers in the U.S., as well as a fixed asset adjustment, as Soma mentioned. We conceded some disputed items at year-end in order to accelerate the collection of receivables from these customers. Excluding the higher-than-usual reserves for customer concessions, bad debt and other charges, full year 2019 adjusted EBITDA was $259 million, and fourth quarter of 2019 adjusted EBITDA was $52 million. In spite of the increasingly challenging market conditions in the last half of the year, cash flow generation continued to be a bright spot for Apergy. Cash flow from operating activities for the year remained strong at $156 million as working capital was reduced year-over-year and helped offset partly lower operating earnings. In addition, due to our capital discipline, full year 2019 capital spending was constrained and ended the year down $18 million compared to 2018. As a result, free cash flow improved year-over-year and ended 2019 at 10.3% of revenue.
Turning to slide nine. We've continued to navigate a challenging market environment in North America. Looking at rig count, the average U.S. rig count in the fourth quarter declined 11% sequentially, and the year-over-year change in the average rig count was an unfavorable decline of 24% as a result of an estimated 9% reduction in North America E&P capital spending. Looking into 2020, North American E&P capital spending is expected to further decline an additional 11%, with international spending projected to be a bit of an offset as international spending should be up in the mid to single digits. We expect that our North American customers will remain disciplined in the coming year, while the longer-cycle projects will lead to growth opportunities in the international markets. We continue to believe that as a best-in-class provider of equipment and technology, with industry-leading customer service capabilities, we need to take advantage of these capabilities to maintain and gain share even in a tough market environment. In addition, after the closing of our merger with Champion X, we'll have a much larger international footprint to leverage and drive increased growth, including access to international and national oilfield customers where Apergy does not have a large presence today.
Moving on to slide 10 and looking at consolidated full year performance. Revenue declined 7% due to lower North America activity levels, including the impact of the decrease in U.S. rig count and the related influence of destocking of PDC inserts by our drill bit customers in Drilling Technologies. The lower E&P capital spending, of course, also constrained our artificial lift revenues in Production & Automation Technologies. Excluding the higher-than-usual reserves for customer concessions, bad debt and other charges in the fourth quarter of 2019, adjusted EBITDA decreased 12% due to the lower revenue, which was partially offset by the benefits of cost reduction actions and productivity initiatives. Free cash flow generation remained strong during 2019 with more than 10% of our revenue and 46% of our adjusted EBITDA converting to free cash flow. Both metrics were ahead of 2018 performance. Turning to slide 11 and looking at the full year segment performance, both of our segments felt the impact of capital discipline in North America in 2019. On an operational basis, during 2019, our Production & Automation Technologies segment performed very well. Excluding the higher-than-usual fourth quarter charges, adjusted segment EBITDA margin for the Production & Automation Technologies was 21%, 40 basis points higher than the 2018 performance.
Additionally, within Production & Automation Technologies, digital product revenue grew 13% from 2018. Against the difficult North America backdrop, we maintained solid year-over-year operational performance. Our Drilling Technologies segment was more heavily impacted by the destocking of polycrystalline diamond cutter inventories by our oilfield service customers in the second half of 2019. We estimate the impact of this destocking in 2019 to be approximately $27 million of revenue. Within both segments, we took significant cost reduction actions in 2019. As we move into 2020, we'll be working to build on these cost reductions and continue to demonstrate our cost discipline designed to match operational capability to market demand. Moving to slide 12 and looking at the consolidated fourth quarter performance, we recorded a net loss in the quarter of $2 million and the diluted loss per share was $0.02.
After adjusting for the impact of spin-off acquisition transaction expenses, mainly associated with Champion X and restructuring-related items as well as other charges related to intellectual property defense and extended filing costs in the quarter, adjusted net income was $10 million, resulting in diluted earnings per share of $0.13 in the quarter. We generated adjusted EBITDA of $45 million during the fourth quarter, excluding the higher-than-usual reserves noted earlier, fourth quarter adjusted EBITDA was $52 million, a decrease of $11 million or 18% compared to $64 million in the third quarter of 2019, and a decrease of $26 million or 33% compared to the fourth quarter of 2018. Year-over-year and sequential decreases were primarily driven by the sharp decline in U.S. drilling activity in the third and fourth quarters of 2019, and the related destocking impacts by our drill bit customers of their polycrystalline diamond cutter inventories. We were also affected by the pullback in customer spending on artificial lift by our E&P customers in North America. In the fourth quarter, net interest expense was $9 million, which was 5% lower than the third quarter as we're seeing the increasing benefits of our deleveraging plan.
In the fourth quarter, we continued our debt reduction efforts and repaid another $30 million of term loan debt from available cash. In 2019, we retired $105 million of term loan debt and since completion of the spin-off on May 9, 2018, we've repaid $150 million of term loan debt or 21% of the initial $715 million in debt taken out at the time of the spin. In the fourth quarter of 2019, our provision for income taxes was a benefit of $9 million. The decrease in taxes was primarily due to tax benefits resulting from a true-up adjustments from the filing of our 2018 federal tax return and a reduction in our combined state tax, income tax rate from 2018 to 2019. In the fourth quarter, we invested $8 million in capital expenditures, including limited growth capital associated with surface equipment in our ESP leased asset portfolio. Current quarter capital spending was favorable compared to capital spending of $15 million in the fourth quarter of 2018, and an investment was also down sequentially as we've increased the intensity on capital discipline to further align capacity to market activity in order to safeguard a strong return on investment.
Our free cash flow conversion from adjusted EBITDA and free cash flow as a percentage of revenue metrics in the fourth quarter of 2019 remained strong at 54% and 10%, respectively. Turning to slide 13. Production & Automation Technologies revenue finished at $204 million in the fourth quarter, a decrease of $34 million or 14% from the fourth quarter of 2018 and a decrease of $18 million or 8% sequentially. Excluding the effects of executed acquisitions and divestitures, revenue declined 13% on a comparable basis to 2018. The year-over-year and sequential revenue decline was due to the pullback in customer spending in North America for artificial lift and other production equipment, partially offset by increased international E&P spending and digital revenue growth. Fourth quarter adjusted segment EBITDA was $43 million, excluding the $8 million for the higher-than-usual charges described earlier, which represents a sequential decrease of $7 million or 14%, and and $8 million or 15% year-over-year, driven by E&P budget exhaustion, with particular weakness in December, which was partially offset by the initial benefits of our cost reduction actions.
Excluding the charges previously discussed, adjusted segment EBITDA margin was 21% in the current quarter compared to 22% in the fourth quarter of 2018 and 23% in the third quarter of 2019. Regarding our ESP lease program, our upfront investment in 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 fourth quarter. For the full year 2019, we invested $41 million in new cables and pumps, managing down to the low end of our guidance. For full year 2020, we expect to invest between $20 million and $25 million net of customer reimbursements and the cash from operating activities section of our financial statements supporting the leased asset portfolio. The significant year-over-year reduction planned for 2020 is due to the forecasted decrease in North American E&P capital spending as well as our efforts to be much more selective on how we allocate capital to customers, resulting in a high grading of our leasing customer list.
We will also be constraining capital available for lease and attempting to drive more customers toward purchases of equipment in 2020 to better balance the portfolio of revenue. Moving to slide 14. Drilling Technologies posted revenue of $44 million in the fourth quarter, representing a decrease of 20% sequentially, compared to a 5% decrease in worldwide average rig count and an 11% decrease in the U.S. average rig count. The $11 million sequential decrease in revenue was consistent with our guidance and came about as a result of the continued decline in the U.S. rig count and ongoing destocking of polycrystalline diamond cutter inventories by our drill bit customers. Compared to the fourth quarter of 2018, Drilling Technologies revenue decreased 42%. Additionally, in the fourth quarter, revenue from diamond bearings was $6 million, down from $7 million in the third quarter due to capital discipline of our oilfield service customers as they defer spending on downhole drilling tools. We estimate that destocking had an incremental negative impact of $4 million to our fourth quarter revenue on top of the negative $12 million effect in our Q3 results.
In addition to the influence of destocking, as a result of the reduction in the U.S. rig count, we also experienced lower deliveries of bearings due to capital discipline by our oilfield service customers. Adjusted segment EBITDA decreased 31% to $11 million in the current quarter from $17 million in the third quarter of 2019 due to lower volumes, partly offset by the benefits of cost reduction actions. As we've previously shared, we experienced higher decrementals to adjusted segment EBITDA in the Drilling Technologies business during periods of sharp declines in revenue. Year-over-year, adjusted segment EBITDA decreased 61% from $30 million in the fourth quarter of 2018, due to the steep revenue decline tied to the reduction in the U.S. drilling activity. Adjusted segment EBITDA margin was 26% in the fourth quarter of 2019, compared to 30% in the third quarter of 2019 and 39% in the fourth quarter of 2018, as cost actions taken exiting the third quarter were only able to partially offset the effect of the revenue decline. As you can see on the chart at the bottom of this slide, weekly orders for drill bit inserts bottomed in September of last year, and after hitting the inflection point, orders began to stabilize in the fourth quarter. In January and February of this year, we have continued to see improvement in order rates.
And as a result, we expect a sequential increase in our Drilling Technologies revenue. Moving ahead to slide 15, on the balance sheet. Fourth quarter ending debt, net of discounts and deferred financing cost was $560 million. Cash at the end of the quarter was $35 million. As previously noted, we repaid another $30 million of debt on our term loan, consistent with our commitment to our capital allocation priorities, which include funding our organic capex needs tied to our growth accelerators, as well as reducing our leverage through debt reduction with excess cash flow. At December 31, 2019, Apergy's net debt leverage ratio was 2.1 times, up from 1.9 times at September 30, due to the reduction in the trailing 12-month earnings and our available liquidity was $279 million. Turning to slide 16. Consistent with our expectation of market activity sequentially improving in the first half of 2020, for the first quarter of 2020, we expect consolidated revenue of $255 million to $265 million and adjusted EBITDA of $50 million to $56 million.
While improvement in revenue and earnings is expected in both of our segments, we do anticipate some increased costs in support of our digital growth initiatives as well as incrementally higher expenses across the businesses sequentially due to resetting of bonus accrual assumptions, payroll taxes and other payroll-related items. For the first quarter, we anticipate that interest expense will be approximately $9 million, and that our depreciation and amortization expense will be approximately $30 million. Our effective tax rate is expected to range between 22% and 24% in the first quarter.
Our full year 2020 capital spending forecast is approximately 2.5% of revenue for infrastructure-related growth and maintenance and $5 million to $10 million for capital investment in surface equipment for our portfolio of ESP leased assets. For 2020, we anticipate another solid year of cash flow generation and expected free cash flow as a percentage of revenue to be consistent with 2019 performance at approximately 10% of sales.
At this time, I'll 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. Before we open the call to questions, I would like to update you on our progress on the key growth initiatives for 2020 and beyond. In our ESP growth initiative, we commercialized a new product in the fourth quarter called PowerFit motor for slimhole ESP applications. The PowerFit motor will provide customers increased productivity in smaller diameter and conventional wells. And it is a demonstration of our efforts to continually improve our products for the benefit of customers. We have seen good adoption for this new technology by our customers, and we are excited about this new product. We continue to remain focused on expanding our presence with international oil companies. We are making good progress with the IOC we secured in Q3 of last year. We expect to capture field trial with at least one additional IOC in the first half of 2020.
With the E&P capital spending in the U.S. shifting to the super majors, we believe that it is important to grow our relationship with these important customers. Additionally, we expect to leverage the relationship with Champion X with these customers once the merger closes. Our second growth initiative is focused on existing well conversions to Rod Lift as production declines. Against the backdrop of a 9% decline in full year 2019 E&P capital spending in North America, we achieved low single-digit revenue growth in our Rod Lift product line for full year 2019. During 2019, the relative performance of this product line is impressive and demonstrates the value we provide to customers through our high-quality OEM products and excellent aftermarket support as they work to convert the growing pool of Rod Lift conversion candidates. Turning to our digital growth initiatives. During the quarter, we announced an important technology development agreement with the DCP Midstream, which will enable us to augment our artificial intelligence predictive models and our Spotlight smart-hardware edge technology with DCP's process data and operational knowledge to increase asset reliability, enhance safety and improve efficiency for midstream operators.
We are privileged to partner with such a well-respected midstream operator in DCP and believe, it is a testament to our digital capability and the quality of the products and services we provide. Additionally, we launched XSPOC 3.0 production optimization software. This software has a number of powerful updates driven by artificial intelligence and advanced physics-based models that help our customers reduce lifting costs and increased production efficiency through real-time optimization of artificial lift and chemical injection performance, enhance the surveillance for safety and environmental protection. In 2019, we achieved 13% growth in our digital products and services, we expect to achieve another year of strong growth in 2020. Our fourth growth initiative is the continued innovation and advancement of our Diamond Sciences technology. In the fourth quarter of 2019, our Drilling Technologies segment had 21 new patents issued, bringing the total issued patents since the beginning of 2008 to 806.
We also continue to develop application-specific design for our polycrystalline diamond cutters across multiple basins to enhance performance in both abrasion and the impacted applications. We are committed to advancing our Diamond Sciences technology and bringing the best technology to our drill bit customers to enable them to drill faster while reducing E&P operators' overall drilling costs. Our final growth initiative is focused on driving continued adoption of our diamond bearings in downhole applications, including rotary steerables, mud motors and power generators. For full year 2019, revenue in this product line grew 7% compared to 2018. In the second half of 2019, our diamond bearings product line was impacted by the capital discipline of our oilfield service customers. Due to the effects of capital discipline, we do expect the adoption rate by our oilfield service customers to slow, however, we continue to make good progress on developing non-oil and gas applications for this important technology.
During the fourth quarter, we continued to advance our growth initiatives and against a challenging macro environment, we continue to operate with cost discipline while achieving important strategic goals. During 2020, we will work to successfully execute our planned merger with Champion X and continue to drive growth across our businesses. 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'm proud of their accomplishments, and it's 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
[Operator Instructions] And our first question comes from Chase Mulvehill.
Chase Mulvehill -- BofA Merrill Lynch -- Analyst
Hey,good morning.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Good morning.
Chase Mulvehill -- BofA Merrill Lynch -- Analyst
I guess, first thing, if I can just come back to the guidance for 1Q a bit. And maybe if you could just provide a little color about how you think revenue growth will be split between the segments? And then maybe some help on the PAT margin outlook for 1Q, given that there was some moving pieces in the fourth quarter?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes. So getting looking at both the segments, starting with the Drilling Technologies. So we do as we mentioned in our prepared comments, we are seeing the sequential growth in order rates. So we expect Drilling Technologies to show sequential improvement. And along with that, we expect margins to improve compared to the fourth quarter. Now with respect to PAT segment, we expect sequential improvement in revenue. But on the cost side, we are going to see some reset of certain costs, particularly around the digital we are making some growth investments in digital. And the bonus reset as well as some payroll-related costs will reset.
And this is something which we typically see in the first quarter of the year. So if you go back and look at Q4 to Q1 of last year, you would see a similar phenomenon. So you'll see sequentially, we expect the PAT margin to be marginally lower compared to what we saw in Q4, but we would expect that margin to improve as the year progresses. So as you know, say, as we typically talk about PAT margins to be in the 20% to 21% range. So they're maybe a tad bit lower than the 20% in the first quarter, but we do expect the PAT margins to get back into that range as the year progresses.
Chase Mulvehill -- BofA Merrill Lynch -- Analyst
Okay, great. That's helpful. Appreciate the color. And then noticeably absent from the prepared remarks, at least I didn't hear anything about the impact from China on the supply chain side, whether it's from the diamond grid or anything related to the lift business. So you guys expect to have any impact in 1Q or maybe in 2Q?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes. I think for us, it's in, I would say that in the that the two areas you correctly mentioned, the diamond grid as well as SMB in the artificial lift, particularly around the ESP product line. And we don't expect any major impacts on the diamond grid side, I think it would be sufficient, at least for the Q1 and Q2. And on the ESP side, I think the impact on Q1 will be marginal. But if things continue to progress, and we don't see opening up meaningful opening up of the supply chain well into, let's say, in March, then we may start seeing an impact in Q2. And I would say that, that would be I would expect it to be an industrywide impact.
For us, our main supplier in ESP product line is actually back to work. So we are in constant touch with them. But we do have some other components for which the suppliers are still not back to work. We have enough inventory and our leased asset portfolio, as you have seen is, we have enough of that to continue Q1. I think we have to see how Q2 shapes up..
Chase Mulvehill -- BofA Merrill Lynch -- Analyst
Okay, already. So I have alternate back over there. Thank you so much.
Operator
Our next question is from George O'Leary[Phonetic].
George O'Leary -- Analyst
Morning, guys.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Morning.
George O'Leary -- Analyst
On the international activity outlook, you all mentioned that you could see just kind of underlying activity up in the mid-single digits ballpark. Last year, you guys kind of outpaced that international activity growth at the revenue line, the 12% growth in international revenues. I wonder if you could frame the expectation for international revenues this year, even if just as a percentage or a multiplier versus that expected growth in international activity?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes, George. I think we expect, I think, for what we have said before, is over the next 3, four years, we expect to consistently outperform the market with respect to international growth. So I think you should expect us to meaningfully outperform the E&P spending, which we think will be up about low to mid-single digits internationally. And you should expect us to meaningfully outperform that.
George O'Leary -- Analyst
Okay. That's helpful. So thank you. And then the chart that you guys have on page 13 in the lower right, showing the ESP demand snapback is in unit one, I was just curious for that Production & Automation Technologies segment, are you seeing a similar trend across the other forms of lift? And then just generally how our conversions to Rod Lift progressing? Are guys slowing that conversion cadence down, given the desire to preserve cash flow or E&Ps doing that? Just curious about those two items?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes. So I think sequentially, we are seeing activity improvement from December in pretty much, I would say, all of our artificial lift product lines. With respect to the Rod Lift, I think one thing we are monitoring with the Rod Lift as a capital discipline is around the conversion. One of the things with a couple of customers we have noticed was they are plugging and abandoning some low-flowing wells. So when you think about wells that are flowing at 15 or 20 barrels a day type well, and sometimes we use that equipment for the conversion at 150 or 200 barrels a day wells, converting them to Rod Lift. So we have seen a little bit of that. So but I do think that the conversion will be an ongoing process, but we are seeing this interesting phenomenon, how they are reusing the equipment by plugging some real low-flowing wells. So that's only other thing we noticed new in the fourth quarter.
George O'Leary -- Analyst
Very helpful color. Thank you so much. Thank you, Jay.
Operator
Our next question is from Scott Gruber.
Scott Gruber -- Citigroup -- Analyst
Yes, good morning.
Jay A. Nutt -- Senior Vice President and Chief Financial Officer
Good morning. Scott.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Good morning. Scott.
Scott Gruber -- Citigroup -- Analyst
Starting on the digital business, just to try to frame up the growth for this year. If we think about the lift business just being kind of flattish this year, exit to exit, how should we think about growth on the digital side?.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes. I mean, I think Scott, I think, as we said in the prepared remarks, we expect a growth a strong growth in the year. And look, I would say, our aspiration in the digital business is continue to have at least a low double-digit type of growth in our digital business year-over-year. As you know, now it is 13% in 2019 versus 2018 in what I would call it a challenging North American market backdrop. So we expect 2020 market backdrop to be challenging. But given our new products we are introducing and continued adoption, we believe we should be able to achieve again there, I would say, of aspiration of low double-digit growth in digital.
Scott Gruber -- Citigroup -- Analyst
Got it. And just turning to the cost side of the equation. You and your peers continue to adjust the cost base given the new backdrop here in the U.S. Are you able to quantify how much more savings is possible as you address the cost base here in 2020?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes. I mean, I think what I would say here, Scott, is that I think in fourth quarter, if you look at year-over-year, I think that cost savings was roughly about $5 million. And we expect to build on that in as we come into the second quarter and third quarter because we are continuing to look at options and continuing to make that as part of our ongoing effort. So I don't want to quantify much on this call, but you should expect that $5 million to get better.
Scott Gruber -- Citigroup -- Analyst
Got it. Maybe I'll sneak one last one in. Just an update on the non-oil and gas applications for your diamond technology. Are we going to see the announcement on that front from a commercialization standpoint in 2020?
Sivasankaran Somasundaram -- President and Chief Executive Officer
We are progressing well on that, Scott. I think, as we have mentioned before, it's it takes time. We said it takes about two to three years before we can break into a new application because of the testing requirements required. So I would say that we are progressing well on that, and we have we are investing more in that area. We are redirecting some of our investments into those areas. So I think you should see us continue to update in the calls about how we are progressing on that.
Scott Gruber -- Citigroup -- Analyst
Appreciate the call. Thank you.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Thanks. Scott.
Operator
Next question is from Cole Sullivan.
Cole Sullivan -- Wells Fargo -- Analyst
Hi, good morning. On the drilling business, what is your sense of inventory levels at customers currently? Obviously, they've been picking up on the order front over December, January and February. I was just kind of curious on how low they got during the destocking. And how much catch up they may need to do?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes. I mean, I would say, at this point, I would say, pretty much all of the customers whom we talked to have literally reached the destocking bottom and the process of started the process of restocking. Now how far they will go with restocking, Cole, is something hard to predict given the headcount trajectory assumptions. So but the two things that drive here for our sequential growth in drilling technology is if you look at the rig count trajectory, rig count does not move, right?
If you think about from Q4, actually, to some extent, this margin rate come down when where we exited Q4 versus how Q1 where it is now. But the restocking aspect has been a big driver in the initial phases of January. And then our own share gain growth is the other aspect of it, which is also driving our continued order rate. So I think, I feel that Q1, you should see a meaningful growth in the Drilling Technologies business, but the combination of both the restocking in the initial stages of January. And the what we are seeing now is more of what you are seeing in most of February is our own share growth plus the stable order rates, which we are seeing. So I expect a February kind of order rates to is to continue.
Cole Sullivan -- Wells Fargo -- Analyst
Okay. And then you mentioned margins, you're obviously improving in drilling in the first quarter with the rebound. Is there any way is there any reason we shouldn't see these margins get back to above 30% later this year, even despite of the North American headwinds that we're seeing?
Sivasankaran Somasundaram -- President and Chief Executive Officer
I think there is no reason it wouldn't get above the 30% as we get as we go further into the year, Cole. I don't see a reason why this one...
Jay A. Nutt -- Senior Vice President and Chief Financial Officer
As long as activity stabilizes, where we're at right now, we would we think that's a safe assumption, Cole.
Cole Sullivan -- Wells Fargo -- Analyst
All right. Thank you. I'll turn it back.
Operator
Our next question is from Blake Gendron.
Blake Gendron -- Wolfe Research -- Analyst
Thanks. Good morning. My first is on the ESP side. You gave us the spending going down 11%. You also mentioned that you're trying to high-grade some of your customers. You also mentioned IOC penetration continuing. Wondering if you expect to outperform or underperform just the organic ESP spending in fiscal 2020, given those inputs?
Sivasankaran Somasundaram -- President and Chief Executive Officer
I would say, I'll ask Jay to make a couple of comments related to the least part of it. But I would say with respect to we expect to outperform the spending down on our own capital spending down. And part of it is Blake, I would say that we are focused on converting some of these customers to purchases. So I think that will help and the continued penetration with I will see. We mentioned that we are making really good progress with the one IOC we secured in the Q3 of last year. So that's continuing well. So we will outperform the spending in our own spending down. So Jay, any further comments on that?
Jay A. Nutt -- Senior Vice President and Chief Financial Officer
Yes. As Soma mentioned, Blake, we're taking the number down, but we like we have in the prior years, we tend to outperform the overall market based upon share gain initiatives and penetration, and we would expect that, that technology and customer service focus would allow us to continue to outperform in 2020 relative to 2019. But we are taking some capital down just to make sure that we are preserving the best returns and allocating capital to the best paying customers in 2020, so that we can top grade the customer list.
Blake Gendron -- Wolfe Research -- Analyst
Understood. That's helpful color. And then another on the artificial lift business. Some of your larger peers have talked about the challenged state, the commoditized state of that business. I'm just wondering what you would say to push back on that sentiment. And then maybe if you've seen a step change in commerciality from some of the larger peers, whether or not that would be an opportunity for you to maybe take additional share or at least to the profitability in that business moving forward?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes. I mean, look, I think in artificial lift, as we have said before, the important part of our differentiation and artificial lift revolves around two things. Our customer service, being a pure-play artificial lift player, we are able to respond and our field network is extensive in North America to help us respond quickly to customer needs. And second is deep applications knowledge, the ability to augment that with our digital solutions, to continuously help customers reduce the lifting cost.
So I think for us, I think, staying focused on customer service and continue to evolve our product line to help customers improve productivity is continuing to help us. With respect to improving margins, I would say, look, I think that competitive landscape, particularly in broad lift is evolving. As you've probably seen and heard. So I think it's something we are watching just to make sure that how that competitive landscape is going to evolve. And every opportunity we get, we are always looking to see how we can increase our share position as well as improve our margin profile.
Blake Gendron -- Wolfe Research -- Analyst
Got it. Yes. I meant discussed by Rod Lift there, but that's helpful perspective. And one more if I could squeeze it in. Just digging into the nature of the cost reductions in the Drilling Technologies segment specifically. Just wondering if you could characterize how much of that was structural versus perhaps cyclical. And maybe as you add those costs back on with the restocking phenomenon that you're seeing in the first quarter, should we expect slightly lower incremental margins moving into the back half of the year versus what we've seen historically? Or should they largely be on par?
Jay A. Nutt -- Senior Vice President and Chief Financial Officer
So this is Jay. With regard to the Drilling Technologies cost reductions. Most of that has all been variable as we saw the significant drop off in rig count and cutter volume due to destocking in 2019. The other half of the cost reductions that we talked about on the Q3 call was really more structural on the artificial lift side, and we continue to evaluate more opportunities on structural cost savings on artificial lift.
But with regards to Drilling Technologies, we would expect to see continued high incrementals as volume improves, just as we see large decrementals when the volume drops off in Drilling Technologies but following on the previous question, we would expect to see on a run rate basis with stable drilling activity, margins above 30% exiting 2020.
Blake Gendron -- Wolfe Research -- Analyst
Helpful i'll turn it back. Thank you guys.
Operator
And the next question is from Tommy Moll.
Tommy Moll -- Stephens -- Analyst
Good morning, and thanks for taking my question. I wanted to double back to your comments for the ESP business, where you're looking to shift to more of a sale versus a lease model. What's the level of appetite from the customer standpoint on that? And are there others other suppliers in the market that are approaching this the same way versus you'd see yourselves as an early mover for this?
Sivasankaran Somasundaram -- President and Chief Executive Officer
I would say that the customers, obviously, clearly, in a capital-constrained environment that the set of customers who always want to lease rather than to purchase. But for the right kind of service and technology, the customers will ask what if we cannot lease or we decide not to lease to a particular customer, they'll be willing to invest in purchase. I just want to be I just want to clarify, it's not that we are getting out of leasing. That's not what we are saying. I think what we are saying is, in a market environment which is volatile and challenging, we want to make sure that we derisk our leasing to the right type of customer base as well.
So that so leasing will continue to be an important part of our ESP, both market and revenue generation mechanism. But what we are saying is we will prioritize cash generation and returns, so which will means we will deploy those leasing leased assets to the right opportunities and high-grade opportunities. Now purchasing, we are seeing, for example, the new products we are introducing, right? We are because it's got technology differentiation, it gives us an opportunity to shift those type of products, which are differentiated technologies more and more toward purchasing. So those opportunities do exist. But it will take the focused effort.
Tommy Moll -- Stephens -- Analyst
Okay. That's a helpful clarification. As a follow-up, I wanted to move to a little bit bigger picture question here. Specifically, for the transaction that's pending with Ecolab or ChampionX rather. There's an opportunity to pull-through sales of your existing lift portfolio through their international footprint. I think that's clear and part of the rationale for doing the deal to begin with. Could you drill down a little bit on that theme in terms of what geographies and/or types of or parts of your lift business you feel most excited about that synergy opportunity for?
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes. No, I think you're exactly right. I think the there is a meaningful opportunity for us to leverage the international footprint of ChampionX. I think if you look at the regions internationally, you look at some of the prioritized areas for us, where there is good opportunity, will be in areas like Egypt, Indonesia, certain parts of Latin America as well as places like Ecuador. So these are some of the prioritized areas, where we don't have at Apergy into good international footprint, and it will give us an opportunity to leverage. If you look at the product line, that will range between Rod Lift, progressive cavity pumps and even ESPs, particularly in places like Ecuador, right? So those are that's those are some of the examples of opportunities we will look at.
Tommy Moll -- Stephens -- Analyst
Okay, thank you. That's all for me.
Operator
Thank you. That concludes our question-and-answer session. I'd now like to turn the call back over to Soma.
Sivasankaran Somasundaram -- President and Chief Executive Officer
Yes. Thanks again, everyone, for your continued interest in Apergy. And once again, I want to thank our employees for their great contribution during the quarter. We look forward to talking to you in our first quarterly earnings call. Thank you, and have a great day.
Operator
[Operator Closing Remarks]
Duration: 60 minutes
Call participants:
David Skipper -- Vice President and Treasurer
Sivasankaran Somasundaram -- President and Chief Executive Officer
Jay A. Nutt -- Senior Vice President and Chief Financial Officer
Chase Mulvehill -- BofA Merrill Lynch -- Analyst
George O'Leary -- Analyst
Scott Gruber -- Citigroup -- Analyst
Cole Sullivan -- Wells Fargo -- Analyst
Blake Gendron -- Wolfe Research -- Analyst
Tommy Moll -- Stephens -- Analyst
