Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Gardner Denver Inc. (NYSE:GDI)

Q3 2011 Earnings Call

October 21, 2011 9:30 AM ET

Executives

Barry Pennypacker – President and CEO

Michael Larsen – Vice President and CFO

Analysts

Charlie Mills - Credit Suisse

James Lucas - Janney Montgomery Scott

Kevin Maczka - BB&T Capital Markets

Jeffrey Hammond - KeyBanc Capital Markets

Wendy Caplan - SunTrust Robinson Humphrey

Joshua Pokrzywinski - MKM Partners LLC

Jamie Sullivan - RBC Capital Markets

Scott Blumenthal - Emerald Advisers

Andrew Carter – RBC

Operator

Greetings and welcome to the Gardner Denver Third Quarter 2011 Financial Results. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Barry Pennypacker, President and CEO. Thank you, sir, you may begin.

Barry Pennypacker

Good morning everyone and welcome to Gardner Denver's third quarter 2011 earnings conference call. I'm joined this morning by Michael Larsen, Gardner Denver's Vice President and Chief Financial Officer.

Before we begin with our remarks, Michael has a few comments regarding our forward-looking statements.

Michael Larsen

Thank you, Barry, and good morning everyone. First, a reminder that all the statements made by Gardner 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 of 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 Gardner 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 matters expressed in or implied by such forward-looking statements. Please refer to Gardner Denver's third quarter 2011 earnings press release issued on October 20, 2011 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's or its management's view as of any date subsequent to today.

As a reminder, this call is being broadcast in listen-only mode through a live webcast. This free webcast will be available for replay up to 90 days following the call through the Investor Relations page on the Gardner Denver website at gardnerdenver.com, or the Thomson StreetEvents site at earnings.com, and now I'd like to turn the meeting back over to Barry.

Barry Pennypacker

Thanks, Michael. Gardner Denver had an excellent third quarter, as our teams execution led to yet another quarter of records revenue, operating income, net income and diluted earnings per share. Our orders for the third quarter were $628 million, up 14% versus prior year, up 9% organically and our book-to-bill remained greater than 1, as revenues of $615 million were up 25% – 20% organically. Backlog at the end of the quarter was $669 million, up 20% versus prior year and our strong backlog positions us well for the balance of 2011, and provides us improved visibility into the first half of 2012.

Operating income for the third quarter of 2011 was $107 million, a 57% increase over last year as operating margins improved 350 basis points to 17.3%. Net income was $74 million, up 58% over last year's third quarter as diluted earnings per share increased 61% to $1.42 and $1.48 on an adjusted basis.

In addition, our cash generation was excellent as cash flow from operating activities totaled $97 million in the third quarter and our strong balance sheet enable us to repurchase $126 million of our outstanding shares and announced the agreement to acquire Robuschi for approximately $207 million.

Before I get into the capital deployment into more detail, let me give you a little more color on the organic growth and margin expansion by segment in the third quarter. Our Engineered Products Group continues to experience strong growth, with orders up 7% and revenues up 38%. Orders in this segment can be choppy on a quarterly basis and adjusted for our large order booked in the third quarter of 2010, EPG orders were up 15% versus prior year.

In EPG, the backlog tends to give you a good indication as to where the business is going and our backlog at the end of the quarter was $421 million, up 23% year-over-year. When you look at the increase in rig count and strong growth in unconventional drilling for liquids and natural gas in the shale formations in the United States, it's not surprising that our energy businesses, representing about 20% of total Gardner Denver's revenues, continued to be very strong.

Orders in our pressure pumping business essentially doubled year-over-year and the backlog in that business is three times greater than it was at this point last year. Our drilling pump business doubled revenue year-over-year and continued to grow backlog with orders for delivery through the first half of 2012.

We see no signs of weakness in our energy business and independent research reports and customer feedbacks suggest that the demand for pressure pumping horsepower and the associated aftermarket, particularly for fluid ends will remain strong at least through 2012. Our focus is on making the right investments to take full advantage of this opportunity.

I'd like to give you some examples of our recent investments that we've made. The latest capacity expansions that went on line in Tulsa in July completed a two-year investment program that increased our pressure pumping and fluid end capacity fourfold, lowered our cost and significantly reduced our lead times for our customers. We continue to evaluate the growing demand for our products and services as well as feedback from our customers and it is likely that we will continue to expand capacity again in the near future.

Pressure pumping obviously has a very attractive aftermarket opportunity in the terms of fluid ends and pump repair, and historically it has been less cyclical and higher margin than the equipment side. So as we rapidly grow the installed base, we're also investing in our repair and refurbishment capabilities by expanding and modernizing our aftermarket facility in Fort Worth, Texas.

In addition, based in part on voice of the customer, we recently decided to build a new aftermarket facility with fluid end manufacturing and repair capability in Altoona, Pennsylvania in close proximity to our customers in the Marcellus Shale.

We believe that the trends in unconventional gas exploration will continue to drive strong growth in demand for our pressure pumps and associated aftermarket services well into the future, and we intend to take full advantage of this opportunity. This should provide you with clear evidence that our aftermarket expansion strategy is alive and well and will continue to bear fruit well into the future.

But energy is not the only business that is performing well. Our later-cycle Nash business had a good quarter, with revenues up significantly year-over-year and quoting activity continues to be active on the larger infrastructure projects. While there is some uncertainty as to the timing of these orders in the developed world, demand for our Nash liquid ring pumps in emerging markets such as Brazil and China continue to be strong, driven by strong favorable end-markets like power generation, paper and mining..

We still see lots of opportunities for growth in these emerging markets as evidenced by our Brazilian business doubling in size this year. In the third quarter we also broke ground on new site that will enable the consolidation of Nash's global headquarters and North American manufacturing operations into a new facility outside of Pittsburgh in Bentleyville, Pennsylvania.

Turning our attention to Industrial Products Group, demand for our shorter cycle Industrial Products remained healthy as orders increased 21% year-over-year, 15% organically, as comparisons year-over-year are getting tougher. Orders in Europe and the Americas grew 15% to 25% range year-over-year, but it's fair to say the feedback from some of our European customers and distributors has taken on a more cautionary term.

The same is true for our Industrial business in China which represents about 5% of our total revenues. Over the years, this business has contributed significantly to our emerging markets growth and on a year-to-date basis orders were up in excess of 20%.

In September, we saw softening in demand in China and our orders in the third quarter declined about 5% year-over-year as many of our customers are being impacted by the slowdown in the Chinese economy. This was more than offset by the strength in the Industrial Products Group, including our custom engineered packages business in Asia Pac, which was up significantly on the back of strong demand for our onshore oil and gas customers. While it's hard to predict whether the softening in demand we're seeing in China is going to continue and at what rate, we're confident that given the relative size of the business and the strength of our business in EPG and IPG, it is very manageable.

China remains a very attractive end-market and we will continue to invest as evidenced by our recent new product introduction for China called Black Dragon. Before I discus Black Dragon in more detail, I want to share you a little more detail the accomplishments of the management team that are in Qingpu, China. Led by Brian Wong and supported by people like Haiping Tang, Gary Wong, Michael Chan, Jeff Watson and Grace Chan. This team integrated two businesses that we recently purchased from our joint-venture partner, implemented SAP in this large facility, relocated a large and growing product line from another facility, oh and yes, grew orders in excess of 20%, all in one quarter, this third quarter.

The dedication and determination of this team is evidence that the culture here at Gardner Denver continues to evolve into one that has the trademark of high-performance written all over. Oh and let's not forget they also introduced the Black Dragon. What is the Black Dragon? Our Asia-Pacific team has been hamstrung in the past by having to sell products that were designed and built here in the States and in Europe for these emerging markets. In many cases we were at a cost disadvantage in excess of 35% through the locally produced products.

The Qingpu team delivered the first Chinese designed and built product in the quarter cleverly named the Black Dragon. They use smaller size enclosures for a wider range of flows and by localizing nearly every component have introduced a product line that will provide us a platform to compete with the locally produced products.

Technique has shown that the Black Dragon has exceeded our performance expectations while delivering lower noise levels and better efficiencies. The Black Dragon is evidence that the innovation cycle at Gardner Denver is alive and well, and I want to personally congratulate this team on developing this unique compressor that will enable growth throughout the entire Asia-Pacific region. Nice job by this team and we look forward to the continued introduction of innovative products for these growth markets.

So, while we're cautiously optimistic, we want to be prepared in the event of a potential downturn, whether it's in China, Europe or North America. If macroeconomic uncertainty should continue to increase and potentially translate into weakening demand, we are prepared to pull the trigger on the contingency plans that we've been working on since April. Although the current outlook looks nothing like 2008, we will right size our business again if we have to, just like we did in 2008, and we will once again emerge an even leaner and stronger company.

If anything, the uncertain outlook validates our strategic focus on margin expansion and we remain committed to our strategy of growing earnings and cash flow by expanding our margins in EPG by 150 basis points and 50 basis points in EPG on no volume growth.

Let me just spend a few minutes on margin expansion. Over the past three years, we've focused on margin expansion as the fifth and arguably the most important point of our five point strategy. We drove quite a record. In 2011, we're going to add in excess of $400 million of organic revenue to the top line, compared to 2010 while our headcount is essentially flat. Actually, our indirect headcount is down a little bit year-over-year. That is in part, why our adjusting operating margins are expanding to 18.1% this quarter, up 430 basis points compared to the third quarter of 2010. Both business segments made good progress in the quarter.

In our Industrial Products Group, we recorded our 10th consecutive quarter of margin expansion from 2% in the first quarter of '09 to 13.1% in the third quarter of 2011 achieved through restructuring, productivity and low cost sourcing. As you can see, we are well on our way to achieving our stated goal of 14% operating margin in this business by 2014 as the teams continue to execute very well.

The Engineered Products Group also made great progress from a margin expansion with adjusted operating earnings rising at 23.6%; 390 basis point improvement over year. We've not seen peak margins in this segment yet, and expect the benefit of recent price increases in targeted areas in this segment to flow through the financial starting in the fourth quarter of 2011. While we've made good progress through restructuring and productivity opportunities, we remain – significant opportunities in low-cost sourcing.

This quarter we reorganized the global sourcing team, and I brought in an experienced sourcing leader who drove sourcing results and significant cost savings for me before I joined Gardner Denver. I'm excited to get him back on my team and expect significant contributions in terms of margin expansion through sourcing in 2012 and beyond.

As we grow the business and expand margins, we generate significant cash flow and I'd like to spend a few minutes on how we will be disciplined about our capital allocation here at Gardner Denver. I'm pleased with the $97 million of cash flow from operations in the third quarter, because it’s a sustained cash generation and strong balance sheet that gives us the ability to invest in the business; whether it be machine tools to drive cost reductions on the shop floor or develop innovative products such as the Black Dragon. It also enables us to make selective acquisitions, repurchase shares and pay a dividend.

We did all three of those things in the quarter. We invested $17 million in CapEx to expand our manufacturing and aftermarket capacity to meet growing demand from our customers and to reduce cost on the shop floor. We project that our total year spend to be approximately $55 million, a big commitment by our historical standards, but still well below our D&A.

In addition, we decided to opportunistically repurchase close to 1.8 million shares for approximately $126 million. While we have confidence in our future growth prospects organic and inorganic, we believe that the Gardner Denver stock is undervalued and we view the buyback is an attractive way of creating value for our shareholders. In line with this historical practice, we will continue to buy back (inaudible) on a regular basis and repurchase shares opportunistically.

The fourth point of our strategy is selective acquisitions and I'm very pleased with our recent announcement to acquire Robuschi. Gardner Denver has a track record of buying good companies and making them accretive in year one from an earnings perspective and Robuschi will be no exception. Robuschi is a market leading European manufacturer of blowers and pumps and represents an excellent strategic fit within our Industrial Products Group. Robuschi has a strong brand, a large customer base and a reputation for quality products.

I am confident that we will see sales synergies by leveraging our channels as we're off for a new series of Robuschi branded innovative products, including a dry oil-free screw technology through our well established global distribution network. In addition, Robuschi has a large 300,000 square feet facility in Parma, Italy with advanced manufacturing capabilities, a skilled workforce, and a very talented management team.

This offers opportunities for cost synergies as we transition our higher cost industrial operations within the Eurozone into our lower costs facility. I'd like to welcome the talented employees of Robuschi to Gardner Denver and we look forward to your many continued contributions. Our acquisition pipeline remains active and selective acquisitions will remain an important part of our strategy going forward.

Turning to our outlook for the balance of 2011, we expect our business to continue to show good growth in the fourth quarter of 2011 with particular strength in our energy business. Our backlog, strong portfolio of businesses and continued progress of margin expansion position us well for the balance of 2011.

On an adjusted basis, we estimate our fourth quarter earnings per share to be approximately $1.45 to $1.50, which excludes $0.03 of restructuring and other items. Adjusted earnings for 2011 are expected to be in the range of $5.44 to $5.49 per diluted share, which excludes $0.20 of restructuring and other items. We expect the diluted earnings per share will be up 60% to 62% over 2010 as we wrap up yet another strong year for Gardner Denver. I'd like to remind you that in 2010 we increased diluted earnings per share by 41%. We're beginning to develop a habit.

So in summary, our business had a very good quarter as we set records yet again for the key financial metrics. We expect top and bottom line growth to continue in the fourth quarter 2011 as end-market dynamics remain favorable and we execute on our profit improvement initiatives to deliver superior earnings growth.

While we don't provide guidance for 2012 until the fourth quarter of '11 earnings call, I'm confident that the disciplined execution of our five point strategy, the diversity of our businesses, including the strength and backlog in our energy business, our higher margin aftermarket business, the continued margin expansion through the implementation of the Gardner Denver Way and accretive M&A, coupled with the superior human resources that we continue to accumulate here, we’re in a good position to continue to deliver superior results in an uncertain macro environment.

With that, I'll turn it over to Michael for some more detail on the financials.

Michael Larsen

Thank, Barry. As Berry said, we had an excellent third quarter with strong financial performance and high quality of earnings. Let me just give you some additional details on a couple of areas. First, we continue to make good progress on S&GA. S&GA as a percentage of sales was 15.3% in the quarter, down more than 320 basis points from the prior year as we maintain good cost controls and essentially flat headcounts. So SG&A up 3% with top line growth of 25%.

As we've said before, the Gardner Denver Way goes beyond the shop floor and applies to everyone, including the support function such as finance and over the last 12 months we've been able to reduce our finance costs by approximately $5 million.

One of the key enablers for continued productivity is our new shared service center in the Czech Republic. When the process of transitioning our transactional finance activities such as accounts payable and fixed assets from higher cost countries like the U.K. and Germany to a lower cost facility where we have access to great multilingual finance talent.

As we transition our transactional finance processes, we're also simplifying and standardizing them and we're obviously focused on having the right level of controls and audit embedded. I'm excited about the future of our shared services center strategy and the capabilities that we're building beyond finance, and I'd like to welcome our 42 new employees in the Czech Republic to Gardner Denver.

As Barry mentioned, we opportunistically repurchased 1.77 million shares, or about 3.5% of our outstanding shares at an average price of $71 a share. The buyback is accretive to diluted earnings per share by about $0.02 in the third quarter and $0.04 in the fourth quarter. As of today, approximately 332,000 shares remain under the current authorization from our Board of Directors.

On acquisitions, we're obviously excited about Robuschi and what it brings to Gardner Denver in terms of opportunities for value creation. The acquisition is scheduled to close at the end of November and as we work through the purchase accounting, our fourth quarter guidance does not include a material impact to earnings in the quarter.

Robuschi is performing well and will be accretive to earnings in year one and we plan to provide further detail as we give guidance for 2012 on our fourth quarter 2011 earnings call. The share buyback program and Robuschi acquisition are being funded through a combination of cash on hand and our existing credit facility. We are planning to use the $200 million accordion feature under our current credit agreement and assuming an interest rate of about 2%, this would add roughly $1 million of interest expense a quarter.

In the third quarter, foreign exchange contributed approximately $0.05 to earnings on a year-over-year basis and was slightly unfavorable by about a penny compared to our July guidance. In line with past factors, our updated guidance for the fourth quarter today assumes current exchange rates, which creates a headwind of about $0.03 compared to the third quarter. Our effective tax rate for the quarter was 28.4%, in line with guidance and we're assuming the same rate in our fourth quarter guidance.

So in summary, we had an excellent quarter as we established several financial records for the Company, redeployed capital in a disciplined and balanced way as we gave back to shareholders through the stock buyback and added accretive M&A. Going forward, we're well positioned for continued growth, supported by the Gardner Denver Way, as we remain focused on operating the business well and delivering cash and earnings growth.

So with that, I'll turn it back over to Barry. Barry?

Barry Pennypacker

Yes, thanks Michael. That concludes our prepared remarks. So Dan, we're ready to open it up for questions.

Question-And-Answer Session

Operator

Thank you. (Operator instructions). Our first question is from Julian Mitchell of Credit Suisse. Caller, please proceed with your question

Charlie Mills - Credit Suisse

Hey guys, it's Charlie for Julian. Just had a quick question – I hopped on a couple of minutes late, so sorry if you guys have already answered this question, but just hopped off the GE call, they'd kind of alluded to top line strength and they haven't really been seeing any weakness in their demand from oil and gas customers…

Michael Larsen

We can barely hear you Charlie.

Barry Pennypacker

Charlie, we can't hear you, I am sorry.

Charlie Mills - Credit Suisse

Can you hear me a little bit better?

Barry Pennypacker

Yeah, now I can hear you.

Charlie Mills - Credit Suisse

Alright. Just hopped off the GE call, they had kind of alluded to not seeing any weakness in their oil and gas top line from their customers. Some of the other companies we've heard from like Sulzer cited kind of slowing demand just kind of related to project delays. Just wondering, what your view was? What you guys are seeing from your oil and gas customers?

Barry Pennypacker

Ours is very consistent with GECU. We're not saying any slowdown at all. Our incoming order rate continues to grow. We're talking very intently with our customers. I don't know how much you heard in our prepared remarks, but we're expanding capacity not only at the OEM level, but at the aftermarket level to be prepared for this explosive growth that we're going to see as we continue to fracture in these difficult shale plays and we're positioned extremely well for that and I can tell you that we see absolutely no evidence of a slowdown in this area of our business at all.

Charlie Mills - Credit Suisse

Thanks and then – so would you say that part of the slowdown, I mean, obviously, we saw EPG orders up north of 40% in the first half of the year versus kind of 7% for 3Q. So, do you think that part of that deceleration is because of this added capacity or do you think that it takes longer than a couple of quarters to actually...

Barry Pennypacker

Well, we had some – we had a tough comp coming out in third quarter of last year because we had a very large loading arm order that was booked as well as a one-time very large Brazilian order.

Charlie Mills - Credit Suisse

Because you guys were down sequentially Q4 from Q3 last year. Q3 was very strong.

Michael Larsen

That's right.

Barry Pennypacker

Quite frankly, this is what I want to – the point I want to make about EPG orders, as we continued to grow the aftermarket in this business, we are not going to have the backlog levels that we've had in the past. The aftermarket business in well servicing and P&IP is very, very opportunistic. You have to have the flexibility and capacity, which we've never had before and we have today, where a customer who we've never serviced before, calls us on a Friday and say, 'I need a fluid end delivered 4 o'clock this afternoon, can you do it?' And with the flexibility and the capability that we're adding to our well servicing business, we have the ability to do that now. So we're not going to see a substantial aftermarket backlog in our largest segment within EPG going forward.

Now when you look at – when I look at quarter-over-quarter, the backlog for pumps which are the OEM side of that business, they are extremely strong and they continue to be strong and our customers are talking about the second half of '12 and some are even talking about the first half of '13. So our sentiment is that this business is going to continue to be very strong and when it hiccups, the aftermarket is going to hit in very strongly and you know we don't take investments in bricks-and-mortar too lightly here at Gardner Denver and we've got three of them underway right now and the reason we're doing it is because we expect and we see the opportunity for continued very strong organic growth in these markets.

Charlie Mills - Credit Suisse

Makes a lot of sense. Thanks guys.

Operator

Our next question is from Jim Lucas of Janney Montgomery Scott. Caller, please proceed with your question.

James Lucas - Janney Montgomery Scott

Thanks. Good morning. Michael, a couple of housekeeping questions. First, FX by segment please?

Michael Larsen

There is a schedule in the appendix.

James Lucas - Janney Montgomery Scott

It's in the back.

Michael Larsen

Yes, it's in there. I mean I can walk through it or you can...

James Lucas - Janney Montgomery Scott

No, no, no, it's there. Thank you. And then, is there any way that you could break out for us on those EPG orders given the tough comp? If you take out that loading arm order looking at on a more like-to-like basis, what the orders would look like there?

Barry Pennypacker

Yeah. What you have come to know and love is our P&IP business within the EPG segment, our orders are up, both sequentially and year-over-year.

James Lucas - Janney Montgomery Scott

Okay. And you gave some good commentary on the margin side. Prior you had been talking about getting another 100 basis points on IPG in '12, and given how far you have come this year and let's assume a steady state that we're not watching TV or reading the press and things are continuing at the current pace. Can you still do that 100 basis points next year?

Barry Pennypacker

No question about it, Jim. I mean we're very, very, very excited about the Robuschi acquisition. You have been with us long enough to know where we did all of our restructuring, when the crisis in '08 hit and that was all in North America, primarily in North America and what we did in Europe was targeted at the EPG Group to improve margin in some of the substandard businesses there. But as we go forward, we have a substantial footprint in the European zone in IPG and the Robuschi acquisition, the 300,000 square foot facility, which is going to start being leaned as we speak, will free up a lot of space for us to continue to look at potential restructuring within the Eurozone in IPG and that's all going to be extremely accretive to the margins.

As I also mentioned, the one disappointment I think we have within IPG internally here at Gardner Denver is the sourcing side of the business. We have not made progress. We've been honest about that. So we brought a guy out of retirement that I know has the ability to do it, who has done it for me in the past and is currently been engaged in the business in two weeks and is already starting to see some very good opportunities for us to source product more effectively. So, the third of the margin expansion that we set out back two and a half years ago really hasn't hit the bottom line yet, so I am very confident that we have the opportunity to continue to expand the margins next year in IPG.

James Lucas - Janney Montgomery Scott

Alright, that is very helpful. And just wanted to flush out a little bit, better understanding the improvement on the new product pipeline. The Black Dragon sounds like a very interesting product to compete locally. What was the development time from when you actually identified you wanted to build that product to when it's hitting the market?

Barry Pennypacker

That's the exciting thing. When we look at some of the internal developments that we've had on a new compressor platform, they have been nine to 12 months. That team in Qingpu did this in six months, from the time they started to the time they completed. It was a great effort. We've got a great team over there. Some of you on this call have visited them and you've got to know them and they are all about performance. They adopted the Gardner Denver Way, they understand the innovation cycle and as we continue to get the businesses in developing countries, understanding that that third point of our strategy, innovation is not immune in these developing countries, we'll continue to make very good progress with innovation in the areas that are needed and that team is really developing a core competency in product development and we're going to leverage that not only for Asia Pac, but for other regions around the world.

James Lucas - Janney Montgomery Scott

Okay and final question, just a big picture here. Clearly, a lot of good things going your way both from a end-market as well as still a lot of internal levers to pull, but given the uncertainty that seems to persist out there, what are the key data points that you're watching internally?

Barry Pennypacker

Depending on the segment. In IPG, we continue to watch of course ISM and we'll watch PMI as well as capacity utilization and all those are somewhat mixed sentiment at this point. So I remain very cautious, but I will tell you that as I started looking at our progression of IPG orders, particularly in Europe, from the beginning of the year through the end of September, it's a straight line up. We continue to grow every single month in the Eurozone in IPG. With regards to EPG, we of course look at again, large capital investment. We follow the large E&C firms and what their capital spending is looking like as well as rig count and as you know rig count in the U.S. is hovering around 2,000 now and the international continues to grow and so they are the main drivers that we look at on a weekly basis to determine whether or not there are strength or weaknesses in our business.

James Lucas - Janney Montgomery Scott

Great. Thank you very much.

Operator

Our next question comes from Kevin Maczka of BB&T Capital Markets. Caller, please proceed with your question.

Kevin Maczka - BB&T Capital Markets

Good morning. Barry, I'd like to start on pricing. You made a comment on that this morning, and I think in the past you'd said, maybe there are some areas where you're not – or you have not been pushing on price as much as you otherwise would while you try to clean up some of your own inefficiencies. So can you just say a little bit more about the pricing dynamic right now and what specifically you're doing?

Barry Pennypacker

Yeah. In the first three quarters of the year I can with a sound mind, tell that we have basically offset inflation with our pricing activities. But going forward, particularly in the fourth quarter within EPG, we have opportunistically been able to seek and get price that will in fact continue the margin expansion activities and will contribute – not going to contribute 100 basis points or anything like that to the overall segment, but we certainly will be able to be in excess of inflation in the fourth quarter and beyond.

Michael Larsen

So, Kevin, year-to-date, we've gotten 2.5% of price actually in both segments, which as Barry said has reviews to offset the material inflation that we've seen.

Kevin Maczka - BB&T Capital Markets

All right, great. And then I guess with the stock down this morning and such a strong quarter and outlook, I'm presuming the market is focused on the sequential decline in EPG orders. So do you think the price increase as you're going out with had any impact on that at all or?

Barry Pennypacker

No, not at all. I already told everyone what the reason was for EPG orders being down. I'm not going to say it again. I'm not going to just continue to say the same thing over and over again.

Kevin Maczka - BB&T Capital Markets

Got it. Okay. On IPG, you said you're watching ISM, all the same data points as everybody else. Those orders have been very strong, it sounds like even in Europe and as we look at the total company IPG orders, kind of flat sequentially and holding in very well. So are you saying that's still your outlook as well on the IPG side?

Barry Pennypacker

Yes, because we have substantial opportunity to continue to leverage the product lines that we've acquired through CompAir, through all the different channels globally and we continue to do that and it's all about the first point of our overall strategy organic growth. We're focused on it, we're doing it, we're executing it and it's showing in our order rate.

Michael Larsen

And obviously, Kevin, and you know this, the comparisons are getting more difficult year-over-year, okay. Even though in the third quarter I think the IPG business did a terrific job both on top line and bottom line performance.

Kevin Maczka - BB&T Capital Markets

Right. And then finally from me. Michael, you've talked about some of the nice progress you've made on the finance side and some of the costs you've taken out there and the movement to Czech Republic and elsewhere. Can you just describe how far along in that process you are or are there some next big steps upcoming?

Michael Larsen

Yeah. I mean we're just getting started, Kevin, to be honest with you. I mean we're going to go live here on November 1 in our Czech service center and like I said, right now it's only focused on finance for a select number of countries in Europe. We're going to continue to work that and then we have to look outside of finance and make these shared service centers multifunctional because what we've demonstrated and what I have seen before I came to Gardner Denver is that it is possible to access great talent and perform these activities at a very high level of quality and roughly 40% of the cost that we're paying today and whether it is finance or IT, HR, or legal, I mean, really like I said, I mean the Gardner Denver Way applies to everyone. So we're very excited and we're just getting started.

Kevin Maczka - BB&T Capital Markets

All right, that’s what I thought. Thank you.

Operator

Our next question is from Jeff Hammond of KeyBanc Capital Markets. Caller, please proceed with your question.

Jeffrey Hammond - KeyBanc Capital Markets

Hi. Good morning guys. Just want to see if you could elaborate a little bit on this Robuschi opportunity to kind of further optimize the European manufacturing footprint. How much excess capacity they have to take on, maybe give us a sense of what the cost structure in Italy looks like versus maybe some of your other Western Europe manufacturing plants.

Barry Pennypacker

I'd be glad to. Robuschi is not a lean company. They have the opportunity to apply the Gardner Denver Way, which I'd said, the facility is about 300,000 square foot facility and I believe that with the application of the principles that are contained within the Gardner Denver Way, very consistent with other operations that we have applied the principles to, we'll see a substantial reduction in the amount of floor space. It's necessary to continue to produce the Robuschi product, which will enable us to look at light products that we produce in Europe and move them into that facility. Now, as far as the overall cost structure is concerned, when we look at labor in particular, this would be one of our lowest cost facilities within the European zone.

As well as when we look at material, when we see some of the things that our other businesses have done outside of Italy in particular, we believe there is an opportunity for margin expansion with the Robuschi product through effective low cost sourcing. So we see a great opportunity for overall margin expansion within IPG because of the footprint. The other important point that I think will enable us to show how accretive we can make this acquisition is that the aftermarket percentage of revenue with regards to Robuschi is well below that of the Gardner Denver standard. So, as we apply the principles of the Gardner Denver Way, particularly through policy deployment and the application of our five-point strategy, we believe that we'll see substantial opportunity for expansion of the top line as well as the bottom line to aftermarket

Jeffrey Hammond - KeyBanc Capital Markets

Okay. And then you talked a lot about the frac pump business. Can you just tell me what you're seeing on the drilling pump side?

Barry Pennypacker

Strong demand. Strong demand both within the U.S. and for packages externally outside of the U.S. Our inquiry rate continues to look very strong and our backlog is going out into the second half of 2012.

Jeffrey Hammond - KeyBanc Capital Markets

Okay, great. Thanks guys.

Operator

Our next question comes from Wendy Caplan of SunTrust Robinson Humphrey. Caller, please proceed with your question.

Wendy Caplan - SunTrust Robinson Humphrey

Thank you. Good morning. Barry, we all know that you're not a bricks and mortar kind of guy and could you spend a little more time walking through with us the decision about expanding in Pennsylvania and the Altoona plant and the Pittsburg plant, kind of what you expect to generate in terms of – can you give us some sense of what you're investing there and when and how much maybe size the return on that investment in terms of your expectation?

Barry Pennypacker

Yeah, sure. Let me come at that a few different ways. First, the decision making process that we go through is, when you look at our aftermarket and you do the analysis as to the aftermarket revenue available to us per pump shift, we can do a very detailed analysis to tell us what the revenue per pump is going to be for the next seven years in the aftermarket and it's no secret that we've been shipping four and in some cases five times more pumps than what we ever have in the past on a quarterly basis. So you can intellectually come to the conclusion that if you're shipping more pumps, there has to be more revenue in the aftermarket available for them and that's the decision that we went through. It's a very detailed model. We then sit down with our customers and ask them where they want us to be and it's no secret that the Marcellus Shale is one where the duty cycles are extremely high and that the expansion opportunities are as great as they've been in any of the other shale plays.

So that was the reason for Altoona and when you look at the Fort Worth expansion, we were just in a position down there where we were in a bunch of bungalows that we continued to expand as the aftermarket grew and we just could not be conducive to the flow that I think is necessary for us to reduce our cost. So there is also an opportunity as we go forward to continue to look at other areas of this country and Canada in particular where pumps are going to fracture shale and aftermarket needs are going to be strong. The thing I can tell you is that we are good operators within this company and when you hear me, for those of you who know me, say we're putting bricks and mortar in for the EPG business, you have to know that we have the opportunity to expand our business.

Jeffrey Hammond - KeyBanc Capital Markets

Okay. Thanks you and is there a payback period that you're looking at for these expansions or something else that you can share with us in that regard?

Barry Pennypacker

Yeah. I mean, we do a number of things beyond payback. Return on invested capital has a hurdle rate internally that is very high as well as IRR. But we're of the opinion that if we can show less than one year payback that we should FedEx those in and we'll sign off of them immediately and some of these expansion opportunities that we're currently engaged in fit that criteria.

Jeffrey Hammond - KeyBanc Capital Markets

Okay. Thank you very much.

Operator

Our next question comes from Josh Pokrzywinski of MKM Partners. Caller, please proceed with your question.

Joshua Pokrzywinski - MKM Partners LLC

Hi. Good morning guys. Just want you to dig in on something with the Altoona plant. Just wondering how you guys are calibrating kind of industry-wide capacity coming online and how this may or may not affect the balance, obviously a very strong growth market on the demand side. I'm just wondering what the supply side may look like with this capacity come on. I understand there are some other competitors bringing on more capacity in the first half. Is there signs of reaching equilibrium on supply or could there be an opportunity for the industry to be oversupplied if we were to level off here? Just kind of wondering where we are, supply catching up to demand or trying to work in the anticipation?

Barry Pennypacker

Well, I think we're getting, I think the two are coming closer together, but by no means are we there. I mean our lead times are still longer than what our customers want and that's indicative of the need for capacity. We have historically avoided because we couldn't service a very large portion of this pressure pumping business that we are now feeling like with the developments that we're undertaking in our innovation cycle that we have an opportunity to continue to expand through our innovation, and that's – we don't take those investments lightly and unless we see the opportunity for continued expansion through revenue and ultimately with innovation, we're not going to make those investments. I can't tell you what other guys are doing as far as increasing capacity and what their plans are. I know internally the capacity that we're putting in, the precious funds that we're using to fund these expansion activities are going to yield the types of results that we are going to continue to deliver to our shareholders.

Joshua Pokrzywinski - MKM Partners LLC

This might be getting a little deep into the weeds, but would you mind sharing with us just kind of what the embedded assumption is for fluid end market growth in 2012 since this is kind of what the timing is?

Barry Pennypacker

No.

Michael Larsen

What I would say, Josh, is Altoona is an aftermarket facility and like Barry said, the math that we do here and the detailed analysis is basically to support our installed base and what's in the backlog today. So even if there is a slowdown in demand for pressure pumps, the assumption is that these pumps are still going to run and require fluid ends and that's what this facility – the entire payback is based just on the demand for fluid ends that we see based on the installed base that we have and what's in our backlog today.

Joshua Pokrzywinski - MKM Partners LLC

Okay, that’s fair. And then just looking at the sequential margin improvement in IPG, kind of wondering if there are any big wins there that will really – to credit for that we should be aware of?

Barry Pennypacker

No, it's a matter of continued application of the Gardner Denver Way principles. Some of the investments we've made in some of our larger facilities like Finland and also Sedalia from a capital improvement perspective and being able to be more productive are starting to show fruit.

Joshua Pokrzywinski - MKM Partners LLC

Okay. And then if I could just sneak one last one in here and I don't mean to belabor the point or dig in too much because I know you've already gone in it a few times, but thinking about the sequential progression in EPG orders, and I know you've gone over the year-over-year several times, understanding, are there any engineered package or loading arm orders that we should be aware of 2Q to 3Q or just any issues? I think people are taking more issue with the sequential progression than the year-over-year.

Barry Pennypacker

I could tell you that looking at the sequential progression, on a month-to-month basis; they continue to increase quarter-over-quarter. I think our inquiries remained very, very strong. We track these very closely as you might imagine internally and as I said in prepared remarks, I am not concerned about it, but obviously everyone else is. Remember that we have said that on flat revenue we have the opportunity and we'll continue to deliver 150 basis points in IPG and 50 basis points in EPG and if anyone were to take the revenue that we shift in the third quarter, annualize that and add 50 basis points of margin improvement to that, I think you'd see that's a pretty dug on good improvement in earnings next year.

Joshua Pokrzywinski - MKM Partners LLC

Absolutely.

Barry Pennypacker

So Josh, I'll just remind you that orders in EPG, even in the P&IP business can be lumpy. We've said that many times. I mean, we would receive orders for a three to four months period one at a time and if we actually when we look at our order intake in EPG here, in the fourth quarter here October, we're off to a very good start. So that's why we're not really concerned.

Joshua Pokrzywinski - MKM Partners LLC

Excellent. Perfect. Thank you very much guys.

Operator

Our next question is from Jamie Sullivan of RBC Capital Markets. Caller, please proceed with your question.

Jamie Sullivan - RBC Capital Markets

HI, good morning. Barry, so just to summarize your outlook on what you're seeing in the macro, it sounds like North America is showing some particular strength. Energy remained strong. Europe maybe some incremental caution there from customers and China, you're starting to see some declines. Is that fair?

Barry Pennypacker

That's fair.

Jamie Sullivan - RBC Capital Markets

And is there anything particular in China, particular products or any additional detail you can give us on what that sort of indicates to you?

Barry Pennypacker

Yeah, it's large compressors for factory air is what I think we're seeing the most particular slowdown in the quarter.

Jamie Sullivan - RBC Capital Markets

Okay, great. Thanks. And then, you mentioned that you still expect revenues to be up in the fourth quarter. Is that on a sequential basis? Do you expect it to increase?

Barry Pennypacker

On a year-over-year basis, we're going to see – yes, we're going to see very nice growth.

Jamie Sullivan - RBC Capital Markets

Year-over-year, okay. So you typically do see some strength in the fourth quarter from the third. Any reason to think there'd be a change?

Barry Pennypacker

No.

Jamie Sullivan - RBC Capital Markets

No. Okay. Thanks very much guys.

Operator

(Operator instructions) and our next question comes from Scott Blumenthal of Emerald Advisers. Caller, please proceed with your question.

Scott Blumenthal - Emerald Advisers

Good morning. Barry, you talked about some of the new products that Robuschi is going to bring to the portfolio that did not previously exist?

Barry Pennypacker - President and CEO

Yes.

Scott Blumenthal - Emerald Advisers

And we know that there are certain members of your team who have, I guess have been chomping at the bit to get their hands on some of these. Can you maybe characterize or discuss the magnitude of the opportunity there as you're able to take some of those products that I guess still in the wide space in your portfolio and put those into different geographies?

Barry Pennypacker - President and CEO

Yeah, I mean there is $300 million or $400 million dry screw market in the U.S. currently today that we don't participate in and that's different applications and different pressures, but the Robuschi development and the internal capability that they have with regards to dry technology should enable us to develop products for the North American market that we should be able to get our fair share of going forward.

Scott Blumenthal - Emerald Advisers

And these are products that you would be able to sell into existing customers in the U.S.?

Barry Pennypacker

Through existing distribution networks. I wouldn't necessarily say that they are the same customers.

Scott Blumenthal - Emerald Advisers

Okay. And how about in Asia?

Barry Pennypacker

In Asia, Robuschi already has a pretty good stance in China. However, outside of China, the opportunity exists for substantial growth in areas like Indonesia, areas like Australia, areas like Korea where we have good distribution in place and leveraging their products through those distribution networks should give us a great opportunity.

Scott Blumenthal - Emerald Advisers

Okay. Can you maybe I guess put some quotes around the magnitude there or you're not willing to take a shot?

Michael Larsen

Here is what I'll tell you, Scott. When we get to our guidance for 2012; we're going to get a little more granular around the opportunity on the cost side in particular. On the sales synergies, obviously we know what they are. I will just tell you that as we look at these deals we do not factor that into our deal model, but clearly they are there and we'll get into more detail when we get to guidance for 2012.

Scott Blumenthal - Emerald Advisers

Okay, Mike, fair enough and you mentioned fluid ends a couple of times during the call. Can you maybe talk about your consumption of castings – and we all look at the ISM and castings are one of the commodities that are in short supply right now. Can you talk about the availability and what you're seeing there?

Barry Pennypacker

Yeah, it's tight, but we've been developing sources outside of the U.S. that are starting to come on board in the fourth quarter and first quarter of next year. So we're confident that the supply chain for forgings in particular for fluid ends are in such a shape that we will be able to meet the market demand.

Scott Blumenthal - Emerald Advisers

All right. Thanks guys.

Operator

Our next question is from Andrew Carter of Royal Bank of Canada. Caller, please proceed with your question.

Andrew Carter – RBC

Oh yes, good morning. It's Andrew Carter just calling in from London. I was hoping just to ask you a couple of questions again on the frac pump business. The first one was just in terms of looking at oil prices and I wondered if you could talk a little bit about just sort of the levels of WTI that might affect the outlook for that business?

Barry Pennypacker

Yeah, we love oil. It’s above $80 a barrel and there is talk on where that's going, but fortunately for us our frac business is more aimed at the overall natural gas business here in the States.

Andrew Carter – RBC

Right, okay. And on the – you talked about the aftermarket and about how once you shift to pump then you had pretty good visibility of revenues for kind of the next seven years. Could you complete the picture for us and tell us how big, sort of what relative size the revenues are for each of those years following the initial – maybe in terms of the initial sale of the pump?

Barry Pennypacker

I could tell you that we know what that is and we're not going to disclose that because that's really something that really gives a little bit of competitive information that I'm not willing to give at this point.

Andrew Carter – RBC

No problem, completely understood. Perhaps if I could just ask one other then which is, you've given the – you certainly said that you felt that revenue was reasonably stable in the aftermarket. Could you see any circumstance when aftermarket revenue might actually not materialize?

Barry Pennypacker

I can't see in today's current environment, and using 2008 as a barometer, I can't see an environment where our aftermarket in that particular segment would continue to rise as we have predicted it internally.

Andrew Carter – RBC

Very good. Thank you.

Operator

It appears there are no further questions at this time. I would now like to turn the floor back to management for closing comments.

Barry Pennypacker

Okay. Well, thank you very much for the very good questions and we look forward to talking to you all soon.

Operator

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Gardner Denver's CEO Discusses Q3 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts