Gardner Denver Inc. Q3 2008 Earnings Conference Call Transcript

Oct.23.08 | About: Gardner Denver (GDI)

Gardner Denver, Inc. (NYSE:GDI)

Q3 FY08 Earnings Call

October 23, 2008, 9:30 AM ET

Executives

Barry L. Pennypacker - President and CEO

Helen W. Cornell - EVP of Finance and CFO

Analysts

Jeffrey D. Hammond - KeyBanc Capital Markets/McDonald Investments, Inc.

Kevin R. Maczka - BB&T Capital Markets

Ryan Jones - RBC Capital Markets

Joseph Mondillo - Sidoti & Company, LLC

Michael A. Schneider - Robert W. Baird & Co.

Operator

Good day, everyone, and welcome to the Gardener Denver Quarterly Results Conference Call. Today's call is being recorded. At this time I would like to turn the call over to Mr. Barry Pennypacker. Please go ahead, sir.

Barry L. Pennypacker - President and Chief Executive Officer

Thank you. Good morning and welcome everyone. I am joined this morning by Helen Cornell, Gardner Denver's Executive Vice President and Chief Financial Officer.

We are currently in Shanghai, China where we have one more day left in our trip to visit our facilities. Before we begin with our comments though, Helen has few words on our forward-looking statements.

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

Thank you Barry. All of the statements made by Gardener Denver during this call other than historical facts are forward-looking statements made in reliance upon the Safe Harbor of the Private Securities Litigation Reform Act of 1995. As a general matter, forward-looking statements are those focused upon anticipated events or trends and assumptions, expectations, and beliefs relating to matters that are not historical in nature. Such forward-looking statements are subject to uncertainties and factors relating to Garden Denver's operations and business environment, all of which are difficult to predict and many of which are beyond the control of the company. These uncertainties and factors could cause actual results to differ materially from those expressed and/or implied by such forward-looking statements.

Please refer to Gardner Denver's third quarter 2008 earnings press release issued on October 22, 2008 for further information regarding potential uncertainties and factors that could cause actual results to differ from anticipated results.

Gardner Denver does not undertake or plan to update these forward-looking statements even though the company's situation may change. Therefore you should not rely on these forward-looking statements as representing the company or its management views as of any date subsequent to today. As a reminder this call is being broadcast through listen-only mode through a live webcast. This free webcast will be available for replay up to 90 following the call through the Investor Relations page on Gardner Denver website www.gardnerdenver.com or on Thomson StreetEvents website www.earnings.com. And now I will turn the call back to Barry.

Barry L. Pennypacker - President and Chief Executive Officer

Thank you Helen. We have been in China all this week visiting some of our offers wick business [indiscernible] operation here. Today we had the opportunity to visit the Shanghai locations of CompAir. We are excited about the benefits of the combined Gardner Denver and CompAir businesses and we definitely liked what we saw today at the Shanghai facilities. But as my staff knows, I strongly believe that there are always opportunities to make improvements in all businesses.

I will comment on the third quarter results in a few minutes. But first let me take a few moments to discuss to discuss the transformation that is taking place at Gardner Denver throughout the world.

Yes, I know, that the volatility in the financial markets has created a fear that many in this group has never seen before. And yet I know that there are concerns that the US economy which is much broader than last year's housing and construction issues now at everything. And yes I know that there are significant concerns for the worldwide economy.

There are a lot of macroeconomic conditions that are in a tremendous state of flux right now and frankly, beyond immediate control of our management team. We are developing a number of contingency plans assuming the economic downturn is pro attractive but more importantly also developing plans to proactively improve our business regardless of where we are in an economics cycle.

During the transformation that is underway at Gardner Denver, we are instituting a business system and work closely in lines with our customers as we become a more market driven company and less product driven.

We want to improve the flexibility of our operations so we can proactively scale the operations and frankly develop a culture that embraces change. Our intent is to develop a customer centric, dynamic business system in order to differentiate ourselves from our competition, both in products, resale and services we provide, evolve our business practices to meet customers' needs, anticipate our customers' needs and demands to evolve to a more proactive organization, all of which will drive velocity, not just in our plants but in every stage of our business from R&D to the back office.

There's a lot of change that needs to occur at instituted business system and we will never be done because the system must continue to evolve as the business evolves. The three key elements of our new business system that you will hear us talk about again and again are evolution which is changing to a higher and better state; innovation, introducing new methods; or things and velocity, rate at which an object changes position. You put the three together changing from a... changing to a higher and better state to introducing new method or things while we change the rate at which we are achieving new positions in the market. You get the culture that we are trying to achieve here at Gardener Denver. We are building a culture to embrace all of these things. It will be a way of life at Gardner Denver and it will be called Gardener Denver Way.

You will like me hear me talk more about the Gardener Denver Way in the future, because the business system will shake the future of our company, a future that despite what is going on in the world economy is very bright indeed.

We have started institutionalizing the Gardner Denver Way or it began to lean in many of our plans throughout the world and we expanded in September when I personally led 5 days of training for 60 most senior leaders of the company. The next step for us to get closure to our customers by understanding their current and future and expectations is a logical progression in the evolution of our business system.

However, for now, we have a clear and economic headwind on our business throughout the world and particularly in Europe. Let me take a minute to give you an overview of our thoughts from geographic and end market demand throughout the world.

In general, we're finding some end markets that have deteriorated while the emerging economies have lost some momentum but are still growing. I will be a little bit more specific.

September was a challenging month for us, particularly in Western Europe and United States. In particular we saw notable slowing in the last two weeks of the month in Europe. In some cases purchasing managers simply just put their pens away until they had a better certainty of what was happening in the market. We saw the effect of this in orders for our compressor and vacuum product segment within the quarter and October has not really improved. Therefore we are looking for flat to declining sales in the industrial markets of United States and Western Europe, for the fourth quarter and into 2009. As stated in the press release, visibility into these markets is pretty poor right now, so any comments on 2009 need to be limited to Q1 and not much for -- for as the low pressure in vacuum applications plus the lower horse power compressor price in western Europe and United States have noticeably slowed. But order growth for our medico and environmental OEM applications has held up well through -- in the same regions.

Engineer products which have been a bright spot in our CVP reportable segment for so long are seeing their growth rates slow somewhat. But they're also being compared to rather difficult columns. So it is somewhat expected. But we're really keeping our close eye on though -- our any major project delays or cancellations which we have not yet seen. These engineer products have two key attributes. Many of these -- many are serving process industries particularly mining and oil and gas refining operations.

Volatility and commodity prices could impact some of these projects going forward but the effect is not expected to occur until later in 2009. Nevertheless, we continue to pay close attention. Second, these were all part of significant capital investments, and our portion of the project is not the primary driver. Given the size and financial strength of our customers, we do not believe that the financing is an issue but we are concerned that some new projects that we were expecting to come to bid in 2009 may be delayed. Again, we are watching the market development very carefully.

It is important to note that we do not believe the backlog for engineer products which is a healthy portion of CVP's backlog is at risk. I am specifically discussing future orders for engineer products, which remain strong but have some difficult comps ahead. Coating activity around the globe continues to provide promise. Niche markets such as locomotive and marine compressors remain robust, and both of those also have a pretty strong backlog.

Asia and Eastern Europe remained good growth markets for us although the rate of growth seems to have lost some of the momentum in the last few weeks. We expect these regions to grow high single-digits but still see some slow from the current double digit pace.

In our fluid transfer product segment we had record orders in the quarter as a result of significant petroleum pump demand, and our outlook for 2009 has certainly improved. However, for those of you that don't focus closely and followed the exploration and production space, there's been a great deal of volatility in this segment in the last six months.

As the price of oil and nature gas increased to record levels. The rig count in North America grew a number of exploration and production players announced expansion plans and some very significant increases in our capital budgets. If you recall I know I do, our stock price got a little beaten out earlier this year because we didn't expect growth rates of petroleum pump orders in shipments that married these increases.

At that time, we stated that we thought there would be new rigs built in 2008 but not at the level of 2006 and 2007. In 2006, there are more than 200 new rig builds followed by nearly 350 in 2007.

On the second quarter call we stated that we are expecting about a 100 new rig builds to be built in 2008. Based on our uptick of orders in the third quarter there is probably some upside to the 2008 new build. But, we don't anticipate it'll be more than a 125 reserve rigs built this year. But, many of you will note that recently a lot of the E&P players have reacted dramatically to the sharp decline in the price of oil and gas, a slash in their CapEx budgets and attempting to preserve capital. Frankly, that takes away some of the upside that was available to us later in 2009 particularly in the second half.

Our drilling pump business though is mostly dependent on the volume of new rigs built which we feel are still pretty good entering into 2009. There are three reasons for this. Most of the new rates that are being built have contracts that are already in place. These are primarily for drilling in the shale plays.

Exploration and production firms have leases on land that we'll have to be drilling on. They usually have a very limited time frame on which to drill off in three years. And lastly new rigs generally have a more advanced technology that drill faster than conventional rigs.

The efficiencies that are available with a new rig offer an outstanding return on investment and are desirable in some of the aforementioned new shale plays.

In the end we think that the average rig count may go down in 2009. But we believe that the new build opportunity entering into 2009 is still solid as evidenced by our strong backlog.

Recent discussions with our customers have confirmed this outlook, servicing operations are going to continue as the productivity of the wells decline and there continues to be a need for higher efficiency rigs.

And as we said last quarter, there continue to be opportunities for pumps sold through for rig -- refurbishments and international applications. We continue to pursue those opportunities. We also continue to position a strategic inventory to seize opportunities for quick turning sales and if orders are available, we will work to get the incremental sales. After-market demand remains stable and demand for some of our smaller pumps are at historic highs as a result of some share gains.

Now, let me discuss the future. I want to take a moment to look back at some of the significant accomplishments in the third quarter. First the profit improvement initiatives that we announced early in September. In the process of evaluating our operations around the world, we saw some opportunities to improve the profitability of the business.

It's part of the profitability improvement plan; we're streamlining some of our operations by rationalizing our North American footprint and reducing overhead in North America.

The cost in the third quarter was about $1.7 million. We continue to expect another $4.9 million or so of the costs in the fourth quarter which is included in the earnings guidance we have provided in the press release related to this restructuring plan.

Looking forward, we believe there are significant opportunities to streamline the business as we continue to lean out our operations via the Gardner Denver way. And we'll keep you updated as these continue to develop.

Last quarter we went into a lot of detail about the acquisition of CompAir which I'm very pleased to say closed on Monday of this week. Now that this is part of Gardner Denver we will be moving forward swiftly with implementing our integration plan. We will be attacking our cost synergies immediately with some key areas of focus being manufacturing optimization.

We have identified opportunities around the world for us to rationalize production of CompAir and Gardener Denver into centers of excellence. This will increase productivity, reduce cost and drive velocity.

Because of the local labor loss and employee negotiation processes in the markets where some of the production changes have to take place, the benefits are going to take 18 months or more to achieve. Therefore, this benefit is not currently reflected in the 2009 guidance we have recently provided for CompAir but rather represents an opportunity for 2010 improvement.

General administrative cost synergies. There are some real opportunities for us to rationalize certain admin expenses and functions in this business. Some of this benefit such as leveraging insurance cost is realized immediately and is included in our outlook. Other benefits take up to a year to realize, for example the benefit of bringing compare on to our base ERP system, SAP.

Our CIO and his team are preparing for a November 1 start, and we are excited about the potential of one integrated ERP system integrate across the entire Gardner Denver enterprise. These benefits are only partially included in next year's outlook.

We also think that we can get significant purchasing savings through rationalizing and leveraging our combined supply base. Some of this benefit is included in the later part of 2009 but more fully realized in 2010, as we begin to benefit from their product rationalization efforts.

It is expected that in total we will have significantly more annualized saving in 2010 with the first full year of the benefit occurring in 2011. The point I'm trying to convey is that diluted earnings per share next year is not the peak and that we expect to improve the return on invested capital but we currently think that it will take until 2011 to get there on an annualize basis.

Note that most of CompAir's operations investor costs during Europe. As we know it is more time consuming and expensive to rationalize operations in Europe and it takes a lot longer. Also, the synergies that are discussed are prior to the one time cost that will be incurred to achieve them. Whether these one time costs are charged against acquisition related reserves or expenses will depend on the ultimate determination of where the costs are being eliminated. To the extent that they are eliminated at a CompAir facility, they are charged against acquisition related reserves.

If on the other hand existing Gardener Denver facilities are impacted, the restructuring expenses will negatively affect earnings in that current period. Since we have not made final determinations at this level of detail, I cannot tell you today how the expenses will be accounted for. However as has been in our previous practice when the final determination is made we'll detail any of these one time expenses along with the benefits we expect to achieve for your benefit.

I am thrilled to have this business part of Gardner Denver. It's a great strategic bid that is expected to generate some great cost synergies. We also think that there are significant sales and marketing synergies on top of the cost synergies that I just described.

The leveraging and the mutual distribution networks of the companies, we believe that we can in capture incremental revenues that were available for the... either company individually. In addition, we continue to evaluate other cost synergies that may be available.

Finally, before I give the call over to Helen for some comments on the financial side of the business I want to briefly discuss our current position on acquisitions. We are still looking at deals and we're being very selective about the processes in which we participate. I'd like to describe the reasons for this.

Realization of the integration benefit of CompAir is our number one priority. We are committed to providing a great return on this [technical difficulty] as we have done with our previous acquisitions.

Our top priority is the implementation of the Gardner Denver way. The transformation of this culture and business system that Gardner Denver is not optional. With the tools that are at the cornerstone of this system, such as lean and product development, we will be in a much better position to weather fluctuations in our end markets over the long-term.

The third item is that we will remain selective in the deals that we look at. If they aren't core to our existing operations with great synergy opportunities, we don't think they will ultimately generate the appropriate value for our shareholders.

Finally, we want to keep our deal capacity and powder dry. There maybe some real opportunities that come up in the future. We want to make sure that we are in a position to get them done, again unless they are very strategic such as CompAir, we think there are more valuable areas for management to focus. So, we're being very selective in these transactions that we look at right now. We have plenty of opportunities to create shareholder value through our internal process improvements and completing the integration of CompAir. I feel very good about the runway we have in front of us.

And now I'm going to turn the call over to Helen for a brief review of the quarter before we open it up for your questions.

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

Thanks Barry. Let's start with the CompAir acquisition. As you saw in the release on Monday, the transaction closed at a total purchase price of approximately £201 million, which was about £3 million more than we announced in July.

The primary difference in the transaction price related to working capital adjustment so the value and the business is unchanged we just have a little more working capital reduction opportunity. Now given the outstanding cash we generated in the third quarter from working capital specifically from inventory reduction, I see a lot of opportunities within CompAir as we begin to teach them the Gardner Denver way. Just like the rest of Gardner Denver, they will be undergoing a lean transformation to increase their velocity and the renovation.

The funding for the transaction came through our new syndicated facilities which we announced when we announced to other corporate developments in mid September. So though the credit spread was bit more than what we had in our previous facilities, I think, that in today's market if we try to do it again at present it would even be more expensive. So, I think that we got a great facility put in place with a lot of flexibility. And I think we feel very good about the financing completed particularly in this market.

Based on the terms of the credit agreement and assuming light warm-up rates remain at their current levels I would expect our effective interest rate to be between 7.5% and 8% in the fourth quarter and then decline, I would say, down to 7% or 7.5% as we enter into 2009. Really it's just based on the timing of how long we have certain credit spreads that we're working under.

Even after funding the CompAir acquisition we still will have more than $200 million of dry power available. So, like Barry said, we want to keep that available for the right opportunities should they come along. Center of the facilities is until 2013 so we have plenty of time to look for them. Certainly we would also build to that dry powder as we continue to improve our working capital and generate more cash.

As you saw in our release yesterday we incurred approximately $8.8 million in expense in the third quarter for mark-to-market currency adjustments related to forward currency contracts and cash positions in British pound sterling that we undertook in order to minimize the impact of currency exchange rate on our new credit facility. We do have additional mark-to-market currency adjustments that we expect in the fourth quarter of this year, which we mentioned in the press release.

The mark-to-market adjustment cost related to profit improvement plans and other nonrecurring items resulted in about $14.7 million in additional costs in the third quarter, which we did by GAAP review. I declined to make sure to draw your attention to the final page in our press release, which provides a reconciliation of operating income and diluted earnings per share to the adjusted numbers. We don't expect the schedule to be a regular feature of the earnings release, but do want to provide the transparency to help you understand the inner working with the results within the quarter.

Accounting for the adjustments, operating margin for Compressor and Vacuum Products continued to improve in what has done 12.7% of revenues during the quarter. Particularly notable about that is that we improved sequentially from the second quarter to the third quarter, and you will probably recall that the third quarters when we have our manufacturing shut-downs in holiday periods and Europe and so typically we see pressure on operating margins just because of the reduction in workdays.

Certainly, it's a strong performance improvement year-over-year; it's not where we want it to be, the lean implementation continues to put some downward pressure on operating margin. And certainly there is a continued opportunity for expansion of margins at Compressor and Vacuum Products.

The operating margins at CompAir are less than the average of Gardner Denver's Compressor and Vacuum Products segment, but you should expect to see operating margins of the combined segment blending down in the fourth quarter and into 2009 with the addition of the CompAir business.

We try to spike out the impact of that where we can. Certainly as the businesses get more and more integrated, it becomes more difficult and again we feel like over the long term that business should be improved to the Garden Denver average for Compressor and Vacuum Products.

Fluid Transfer, adjusted operating margins were about 22.5%, similar to what we generated in the second quarter and lower than the 26% reported in the third quarter of 2007. We expect Fluid Transfer product segment margins to expand sequentially into the fourth quarter as we work through the backlog that we have in petroleum pumps which we add to in the third quarter.

I don't think that we will be able to achieve the same level of margins as we generated in the fourth quarter of 2007 though which came in above 30%. I'm sure you will recall that in the fourth quarter of last year, we had a $20 million shipment for LNG loading arms destined through South America which will not be generated again in the fourth quarter of this year. The flow-through profitability on this deal was significant and I would estimate that it contributed to about $0.09 to diluted earnings per share in the fourth quarter of 2007. So even without that, though I think it's very important to notice that we are looking for expanded margins as we go to the fourth quarter in this recordable segment. Barry?

Barry L. Pennypacker - President and Chief Executive Officer

Thanks, Helen. The organic order rate in CVP or Compressor and Vacuum Products this quarter was disappointing for sure. And something that we are focused on is the worldwide economy finds its new level. But, I think we have a lot of good things happening at Gardener Denver and a lot to be excited about. After adjustment, the operating margins for the overall company was strong, particularly in Compressor and Vacuum Products.

The CompAir acquisition is complete and we are on our way to integrating the business and delivering the synergies we have in our model. Our lean implementation is taking hold and showing some quick wins with inventory turns hitting a new company record and expanding operating margins in the compressor and vacuum product segment, we should expect a heck of a lot more of this in the future.

Ultimately, we believe lean will make us a more competitive company as our lead times will decline significantly. Accordingly, we should ultimately expect to gain significant market share.

Cash provided by operating activities was also at the highest than it has ever been in a single quarter, and we generated cash from inventory reductions again this quarter, which puts us in a great position to complete the CompAir deal. This cash flow combined with the financing we now have in place positions us well for our future growth plan.

And most importantly, we've begun to institute our new way of business at this company, the Gardner Denver Way which will provide us a long runway for increased profitability and shareholder value over the long-term. So there's a lot going on at the company which you cannot see from the outside that we can see and we are very excited for what the future holds and rest assured, as always, the people at Gardner Denver are going to deliver.

Dorothy, we are ready for your questions now.

Question And Answer

Operator

Thank you. [Operator Instructions]. We'll take our first question from Jeff Hammond with KeyBanc Capital Markets.

Jeffrey D. Hammond - KeyBanc Capital Markets/McDonald Investments, Inc.

Hi, good morning, guys.

Barry L. Pennypacker - President and Chief Executive Officer

Hi, Jeff how are you?

Jeffrey D. Hammond - KeyBanc Capital Markets/McDonald Investments, Inc.

Doing well. Just wanted to... I guess on Fluid Transfer, just if we think of this as maybe a normal down cycle in terms of oil and gas CapEx that we're heading into maybe in the second half of '09, where... as you look at the mix of Fluid Transfer today versus the same business last cycle, where do you think margins bottom out versus the last downturn?

Barry L. Pennypacker - President and Chief Executive Officer

Jeff, I wasn't here for the last downturn so I really can't tell you that. But, what I will tell you is that I'm a firm believer that when we look at all of our Fluid Transfer businesses in great detail we see significant opportunities for continued cost reduction through the implementation of the Gardner Denver Way. We did the... when you heard that we did the training of the 50... 60 most senior executives in our company, we did that in our drilling pump facility in Quincy, Illinois. And through the lean tools that we were able to train, people were able to go out and actually touch the processes that make those drilling pumps. And we see significant opportunities for the continued expansion of those margins overtime as volume, if it should, continue to drop. For the peak to drop on the current mix I'll turn it to Helen. But I think the business is so different today it's very difficult to answer that question.

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

Thanks Barry. Just to kind of frame things for the participants on the call who maybe relatively new to Gardner Denver. 20% to 25% of the total revenues are in Fluid Transfer Products. In that segment when we were in a period of no drilling pump sales and limited well stimulation pump sales and I would say fair after market partially had margins at 16%. That's in a period when you really didn't have anything going on in oil and gas.

That's the drop level. I would say the peak level it's more or like around 28% and that the trop most recently was touched in the late... maybe fourth quarter of 2004 and the peak I would say was really generated in 2007... first half of 2007.

I don't think we are on our way at this point Jeff to the 16% level. I don't think we're going to be in a period where we are not selling any drilling pumps. I think that we are headed back probably somewhere that's going to be 20% or so in the margins because I think we're still going to see some demand for simulation pumps. We're still selling drilling pumps internationally, we're still selling drilling pumps that go on to rigs in refurbishments when they're trying to increase these efficiencies. And one of our key customers Helmerich is still building flex rigs and our drilling pumps go on, on the flex rig.

So, I don't... I think we're headed lower than we are today as we get into the latter part of 2009, but I don't expect to see us at the trop period, which is probably back to fourth quarter of 2004.

Barry L. Pennypacker - President and Chief Executive Officer

Let met add little more color to that, if I might, Jeff. The business is different today. When drilling pump demand was so high, we utilized all of our clement to build OEM applications. Since then we've invested a significant amount of capital into expanding our aftermarket capability. So, in this cycle we do believe that if there is a significant downturn through the efforts we put in recently to reengineer our fluid ends and give our customers a competitive advantage, the aftermarket ability for us is going to be completely different than what it was in the last downturn.

Jeffrey D. Hammond - KeyBanc Capital Markets/McDonald Investments, Inc.

Okay, great. And then just moving over to compressor back-end products. You speak in the release about the flow or shorter cycle light industry product versus your longer cycle which is proving to be more resilient. Can you give us a sense of how CVP may breaks up between this more flow business versus the longer cycle?

Barry L. Pennypacker - President and Chief Executive Officer

The actual percentages we don't really talk too much about. But let's just say that the slower... the lower value products that are more cyclical do not represent the big... the largest portion of the segment. The industrial... large industrial applications, some of the marine applications, locomotive as well as, all of the engineered products make up the lions share of this segment along with don't forget the Thomas products that continue to grow nicely in our environmental and medico applications.

Jeffrey D. Hammond - KeyBanc Capital Markets/McDonald Investments, Inc.

Great, that's helpful. I'll get back in queue.

Operator

We'll hear next from Kevin Maczka with BB&T Capital Markets.

Kevin R. Maczka - BB&T Capital Markets

Barry, Helen, good morning.

Barry L. Pennypacker - President and Chief Executive Officer

Good morning, Kevin.

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

Hi.

Kevin R. Maczka - BB&T Capital Markets

There was good color on the Fluid Transfer business when look back at past cycles and what the prior peaks and values were in terms of margin. I'm wondering on the compressor and vacuum side if maybe you can do a similar exercise for us on the margins. But also when you look back at past downturns, acquisitions have kind of clouded what the organic growth rate was. So can you maybe talk about in past downturns organically, what kind of volume or revenue declines you've seen.

Barry L. Pennypacker - President and Chief Executive Officer

Let me handle the first part of your question Kevin. I never really focused on what the low end of the margin was in Compressor and Vacuum Products. What I focused on was what was our historical high. Our historical high in this segment back in the late 90s was 14.5% operating earnings. And that is what we are focused on, that is what our management team has put their plans in place to get. I think when you look at the release itself. You can see that we are making significant progress on getting to the 14.5% in this segment much faster than what I had thought. And that's a true acknowledgement to the strength of the Gardener Denver people. As I said before, I think they are most valuable assets and they are embracing lean much better and much faster than any organization I have ever been a part of. And that is what we are focused on 14.5% first, and then we will worry about getting the 20. And that I think you will be surprised to find out will happen sooner than later.

Kevin R. Maczka - BB&T Capital Markets

Okay. And can you just maybe talk about on the top line what past downturns have looked like?

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

I think probably the last time we've had a hard turn would be the 98/99 timeframe. And at that point our business was predominantly North American and predominantly on this shorter cycle business being more industrial and well just in general more industrial standard products. We saw about a 12% revenue decline in that time period. But as Barry just said, more than half of our revenues now in CVP are in that cycle. So, it would not be a typical situation to see a 12% decline this time around because of the broadening plus affect that we have pro forma for the CompAir acquisition about, I think, 14%, 16% of our revenues in Asia, which is still growing high single digit.

Barry L. Pennypacker - President and Chief Executive Officer

And a significant portion of CompAir's revenue as Helen mentioned is not necessarily tight to the low end of the industrial cycle. There's a lot of higher end product that they offer that it goes into high-end process applications which is you may know are still growing at a significant rate on a global basis.

Kevin R. Maczka - BB&T Capital Markets

Okay. Barry, and then CompAir, your guidance and as you look out into '09, I know it's a little more cloudy of course but what is that based on given the exposure to Europe and some of your other comments about the macro picture slowing. Are you expecting that business to grow significantly in '09?

Barry L. Pennypacker - President and Chief Executive Officer

Our model does not have significant top line growth in the CompAir business in 2009. Our model has as I mentioned in my commentary a significant amount of manufacturing synergies as well as SG&A synergies.

Kevin R. Maczka - BB&T Capital Markets

Okay, got it. And just one more if I could. Loading arms... how much loading arm business was there in Q3? And then, as you look forward Q4 you're up against a big comp there that won't repeat. And then, as look out into '09, just talk maybe generally if you could about further demand for loading arms and what you expect there?

Barry L. Pennypacker - President and Chief Executive Officer

Well, we think it's... we continued to quote a significant amount of large projects. Again, I think the global financial crisis has put some of these projects into a wait and see mode. But we have some verbal commitments from a number of large customers on a goal basis for our C&G arms. And our loading arm... the remainder of the loading ARM business continues to grow as we expect. We're up... as you've said, we're up a very difficult comp in the fourth quarter due to the large shipment to South America last year. But, I think overall, we are very pleased about the technology. We continue to invest and we see significant opportunities for CNG.

In fact, here in China there is a significant effort underway to build additional pipelines, to get additional pipeline capacity into the major cities to get that gas here. And as they do that it will give us opportunity for not only loading arms but also for the new and old technology that we acquire with CompAir as well as our own technology for compressing natural gas. So, we see that as a great opportunity.

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

And just to add a little bit more color on the loading arm business itself, but I don't want to quantify what our quarterly revenues are in loading arms even without a large L&G arm shipment in the third quarter, we saw a 20% growth in that particular product line year-over-year for the quarter. So, even without the LNG loading arms are growing and we also are getting after-market parts associated with the large LNG arm. So, that business is very healthy right now.

Kevin R. Maczka - BB&T Capital Markets

Okay, thank you.

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

But it is a though comp in the fourth quarter regardless.

Barry L. Pennypacker - President and Chief Executive Officer

I think we made that clear now.

Operator

We will take our next question from Ryan Jones with RBC.

Ryan Jones - RBC Capital Markets

Good morning. I was wondering how pricing has been holding out and whether or not there's been any impact from commodity deflation at this point?

Barry L. Pennypacker - President and Chief Executive Officer

Well, I can tell you that we are going to fight to the nail to hold our pricing policy. We are in the process of seeing significant reductions in commodity prices on a global basis that will put us under significant pricing pressure as you may imagine but our value to our customer that we continue to offer as a result of our new product introductions, we believe a lot of the pricing that we've already put in the place will stick.

Ryan Jones - RBC Capital Markets

All right, that's helpful. And then I guess lean generated about $14 million in cash flow this quarter, and I was wondering if you had any thoughts about, as we go through 2009, what additional cash flows can be generated from, similar inventory reductions as we move through 2009?

Barry L. Pennypacker - President and Chief Executive Officer

We're going to continue to look for half of inventory turn a year. That's going to be our overall objective. I think, this year we're going to achieve that. So, you can see how much that will generate in cash this year from half a turn year-over-year. And, if you look at that... at the end of December of '08 and add a half return to your model for '09, I think you'll see it's a pretty significant number. We are focused on this, we have a... for the first time, I think processes in place to give inventory reduction. We are no longer talking about them. We are delivering them.

Ryan Jones - RBC Capital Markets

All right, thank you.

Barry L. Pennypacker - President and Chief Executive Officer

Welcome.

Operator

We will hear next from Joe Mondillo with Sidoti & Company.

Joseph Mondillo - Sidoti & Company, LLC

Good morning guys.

Barry L. Pennypacker - President and Chief Executive Officer

Hi, Joe.

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

Hey, Joe.

Joseph Mondillo - Sidoti & Company, LLC

Just first off, I am not sure if I am confusing something. But if you would clear this up, your gross margins decreased in the third quarter just because of product mix in FTP side. However, your operating margins in the FTP segment are increasing sequentially. Could you just clear up that, I am not sure what I am missing here?

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

I think what you are probably missing is that the relative weight of Fluid Transfer for the total. So, yes we are seeing some pressure at the gross margin level, but because the selling and administrative expenses associated with compressor, I am sorry with Fluid Transfer that you are seeing some lift at the operating margin line.

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

Okay, great. And then secondly, if you could... could you give me some more color on how Asia and emerging market exposure's looking? What these environments are like right now, and how worse or how bad do you think that will get in 2009? If you can give maybe like a low digit growth projection or high digits, what do you looking at right there?

Barry L. Pennypacker - President and Chief Executive Officer

Well, if you look at China in particular, we focus a lot of our attention. As I probably talked in my opening remarks, we've been here this week trying to understand the market. And I think it depends on which segment we are involved in, what's going to happen to the growth rate. But, to sit here and tell you that China is not slowing would not be truthful. China is definitely slowing, we are in the middle to high double digits in growth in the past three to five years, whether or not that can continue, I think depends on a lot of factors. However, we do believe based on what we see that at a minimum we are going to be in high single digits growth in the Asia Pacific market.

Joseph Mondillo - Sidoti & Company, LLC

Okay, great. That's it from me guys. Thanks a lot.

Barry L. Pennypacker - President and Chief Executive Officer

You are welcome.

Operator

Our next question comes from Mike Schneider with Robert W. Baird.

Michael A. Schneider - Robert W. Baird & Co.

Good morning Barry, good morning Helen.

Barry L. Pennypacker - President and Chief Executive Officer

Good morning.

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

Hi Mike.

Michael A. Schneider - Robert W. Baird & Co.

Maybe first we can just focus on FTP. So the petroleum pumps today, can you give us a sense of what they are as a percent of the mix. I guess more so on an annualized basis just to smooth out the quarter-to-quarter gyrations?

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

Why don't you ask your next question while I come up with that for you.

Michael A. Schneider - Robert W. Baird & Co.

Sure. And I guess then that really goes back to the period of 2002, 2003, Helen, when FTP was running basically $70 million a year at the trough. I'm curious at least by my historical numbers margins bottomed in the single digits during that period. Why is that they are calling out that the trough is 16%?

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

Well, back in the 2001 timeframe as before we owned the loading arms business. We acquired that as part of the Syltone acquisition in January of 2004. And really by the time we got to the fourth quarter had that business integrated. So, fourth quarter of 2004 is probably your best comparable for the business that we hope today.

Michael A. Schneider - Robert W. Baird & Co.

Okay. And is it fair then when we look back to '02 and '03 to assume that's kind of the core base of petroleum activity at about $70 million if we assume rig counts went way back to 2002, 2003 levels?

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

No, I don't think, well, maybe 2002 and 2003 would be okay. Early... yes, probably that would be better. 2001 we had some nice orders that we were shipping to Helmerich & Payne.

Michael A. Schneider - Robert W. Baird & Co.

Yes.

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

So, you want to go all the way back to 2001. And on your other question, the petroleum business today is about 60... roughly 60% of total fluid transfer on a year-to-date basis, 2008 that compares. I think we were at about 2/3rds of fluid transfer last year.

Michael A. Schneider - Robert W. Baird & Co.

Okay. So, when we compare kind of 2003, that's $70 million based run rate to this year, I think 60% or $400 million we're talking about, call it 2.25 round numbers. How do we think about the $225 million run rate right now, petroleum versus the $70 million back in '03? Is that all rig count growth or how much of that has been aftermarket growth, just so we understand, how bad it can get frankly?

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

Yes, we definitely have improved our ability to provide well servicing comps that we've increased our capacity there which has given us a much better aftermarket. And we've also improved our ability to provide some of the small pumps as well. So, it's not drilling pump, the big difference from one period to the next.

Barry L. Pennypacker - President and Chief Executive Officer

And also the wildcard, this whole thing that you can't see in 2002, 2003 timeframe and even in 2004 is the ability for us to service the aftermarket. Shales that we are drilling in today are much more difficult than shales in the past. It tears up fluid ends, it needs... the wells need more service. So, the aftermarket portion of our business is completely different today than it was back in that timeframe.

Michael A. Schneider - Robert W. Baird & Co.

Okay. And then sticking with FTP, the 30% jump in orders; what's the duration of that order backlog, will you ship most of that by Q1?

Barry L. Pennypacker - President and Chief Executive Officer

I don't know what most means, but if most more than 51%? Is that how you would describe most?

Michael A. Schneider - Robert W. Baird & Co.

Yes.

Barry L. Pennypacker - President and Chief Executive Officer

Then, no.

Michael A. Schneider - Robert W. Baird & Co.

So, it does extend fairly far end of 2009?

Barry L. Pennypacker - President and Chief Executive Officer

It extends beyond the first quarter of 2009.

Michael A. Schneider - Robert W. Baird & Co.

Okay. And then switching to compressor, so orders were down 2% organically and you've called out that September and October... last two weeks of September and October were weakest. Can you give us a sense if the blended average for the quarter was minus 2. Was September down double-digit just to give us some order of magnitude of how fast things deteriorated?

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

I don't have the detail to give you to show a number but I would say that it was the last two weeks of September where we did see the deterioration. The thing that makes it difficult to say that the point in time that it turned is that Europe was pretty much on holiday in July and August. So I don't know if their business had turned and you didn't see it because you weren't getting orders anyway in July and August or if it was earlier than that and it just wasn't visible based on the order rate.

Barry L. Pennypacker - President and Chief Executive Officer

We did have a good booking month is September for our engineering products division which would kind of skew the number that you are talking about Mike. But, I will tell you that literally it was like a light switch, the last week of September, where it just got turned off and people just playing stopped placing orders. I have never seen anything like it.

Michael A. Schneider - Robert W. Baird & Co.

Okay, and as to the engineered packages, Barry, would you expect and I guess maybe even just speaking to October, have orders for the large packages held up and is that primarily the relationship to some of the mining in and oil and gas applications for those packages?

Barry L. Pennypacker - President and Chief Executive Officer

The orders have held up. We continue to have a significant amount of coating activity. Keep in mind the lead time on this product is 12 to 18 months in some cases. So, our backlog is pretty solid going well into 2009.

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

I think it's also besides the oil and gas Mike that you mentioned in mining there's some petrochemical investment in the Middle East that we are still seeing orders coming through on.

Barry L. Pennypacker - President and Chief Executive Officer

Exactly.

Michael A. Schneider - Robert W. Baird & Co.

Okay. And then, I guess just one thing sounded surprising that the OEM portion of CVP seems to be holding up. Is that again just primarily due to contractual relationships that you haven't seen the orders dip, or is there something unique about that mix of OEMs you've gotten there. And then I guess related question is that when you refer to that business, is that primarily the former Thomas business or the Rietschle business?

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

It's the former Thomas business and I think the reason it's holding up better is that it is more tied into medical and environmental applications that aren't as cyclical.

Barry L. Pennypacker - President and Chief Executive Officer

That's right.

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

That's not to say it's not going to slow down, but it's still growing through the third quarter.

Michael A. Schneider - Robert W. Baird & Co.

Okay. Thank you, again.

Barry L. Pennypacker - President and Chief Executive Officer

Welcome.

Operator

We will take a follow up question from Jeff Hammond with KeyBanc Capital Markets.

Jeffrey D. Hammond - KeyBanc Capital Markets/McDonald Investments, Inc.

Hi. Just wanted... you guys are generating a lot of free cash flow, I just wanted to get a sense of... of the CompAir deal how much if any did you fund with cash in the balance sheet? And then, just... can you just talk about other priorities other than acquisitions, I think you said 200 million of capacity. But as you look at... as you guys generate cash where do those dollars go, kind of pay down debt reserve for acquisitions, there may be a new share repurchase program or dividend and maybe just speak to the capital allocations?

Helen W. Cornell - Executive Vice President of Finance and Chief Financial Officer

I will just mentioned the first part, Jeff. We've had about $75 million of cash that we had been accumulating to complete the CompAir acquisition at the end of September. So, we used about $75 million of the $179 to complete the transaction.

Barry L. Pennypacker - President and Chief Executive Officer

Jeff, we're constantly evaluating opportunities for returning value to the shareholders through the generation of cash. In the short term due to the financial conditions of certain markets, we believe it's very prudent to continue to take as much cash as we possibly can and pay the debt down as quick as we possibly can. So, I think in the short-term, you will find that we will generate as much as we possibly can and use it to pay down our debt.

Jeffrey D. Hammond - KeyBanc Capital Markets/McDonald Investments, Inc.

Okay. That's helpful. And then, you talked about contingency planning for protracted downturn, I mean at what point do you start to consider additional restructuring actions or start to accelerate some other cost saving, cost savings actions that you might be contemplating longer term?

Barry L. Pennypacker - President and Chief Executive Officer

Well, we're consistently doing that Jeff. I think the one thing that is different about our company today than in the past is that we don't necessarily have to have a large restructuring charge in order to continue to lean out our facilities and get significant cost savings. As we do that we are freeing up a significant amount of square footage across all of our plans in the entire portfolio.

So, you can just take about what I have been telling the investment community since I came on Board. The first part you will see is a significant increase in generation of cash through better working capital management. You will see some compression of our margins as we produce less, they become more productive in the future. After that you will see significant margin expansion through the opportunities for that lean opens up to us for facility consolidation.

So, far I've been riding on the first two and I think based on what I'm currently seeing that the third and fourth one will be absolutely positively be part of our plan for 2009 and beyond.

Jeffrey D. Hammond - KeyBanc Capital Markets/McDonald Investments, Inc.

Okay, thanks a lot.

Barry L. Pennypacker - President and Chief Executive Officer

You're welcome.

Operator

And there are no questions in the queue.

Barry L. Pennypacker - President and Chief Executive Officer

Okay. Well, thank you all. Have a great day.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation, and have a wonderful day. .

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