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Gardner Denver Inc. (NYSE:GDI)

Q1 2012 Earnings Call

April 20, 2012 8:30 AM ET

Executives

Barry Pennypacker – President and CEO

Michael Larsen – Vice President and CFO

Analysts

James Lucas - Janney Capital Markets

Jeffrey Hammond - KeyBanc Capital Markets

Michael Halloran - Robert W. Baird

Kevin Maczka - BB&T Capital Markets

Joshua Pokrzywinski - MKM Partners

Charles Clarke - Credit Suisse

Jamie Sullivan - RBC Capital Markets

Clifford Ransom - Ransom Research, Inc.

Joe Mondillo - Sidoti & Company

Operator

Greetings and welcome to the Gardner Denver First Quarter 2012 Financial Results Call. 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 call is being recorded.

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

Barry L. Pennypacker

Good morning Rob. Good morning everyone and welcome to Gardner Denver's first quarter 2012 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 prepared remarks, Michael has a few comments regarding our forward-looking statements.

Michael M. Larsen

Thank you, Barry, and good morning everyone. Let me just remind you that any statements made by Gardner Denver during the 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 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 first quarter 2012 earnings press release issued on April 19, 2012 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 with that, I’d like to turn the meeting over to Barry.

Barry L. Pennypacker

Thanks, Michael. Gardner Denver had a good first quarter and a more challenging and dynamic environment. In fact we had our best quarter ever in terms of orders and backlog and the team had its first best first quarter ever in terms of revenue, adjusted operating income and adjusted diluted earnings per share, as we delivered diluted earnings per share at the high end of our February guidance range of $1.40, an increase of 22% year-over-year. In terms of earnings, this was our third best quarter ever.

That said, we've identified areas in the business that continue to improve and need improvement right because I know and my team knows that despite the progress we've made in our lean journey over the past four years, there are so much opportunity left for us to improve the business as we continue to transform Gardner Denver based on the principles of the Gardner Denver way.

The good news is that many of these opportunities are within our control and I will talk a lot about them. Some of the bigger opportunities that will exist over the next 18 to 24 months most notably are European restructuring efforts. However, there are also some things outside of our control, such as the rapidly changing dynamics in an end market that represents about 13% of our 2011 revenues, the pressure pumping industry in North America. We'll discuss in more detail than we have before. What we're actually seeing currently and what we're doing to mitigate the impact to Gardner Denver going forward.

Finally, we had some terrific additions to our senior leadership team this quarter and I’d like to spend a few minutes giving you an update on the organization, but first the financials.

I am pleased with the organic revenue growth in the first quarter of 2012, as revenues were up 14% to $604 million, up 11% organically. Our orders for the first quarter were $680 million, up 11% versus prior year for our book-to-bill of greater than 1.1.

Organically, orders were up 7% year-over-year and sequentially from fourth quarter to first quarter our orders increased 13%. Our backlog is now a record $755 million, up 17% year-over-year, 15% organically which gives us improved visibility to the next six months. In the quarter, order cancellations were $4.8 million, of which $500,000 was in EPG, a fairly normal rate.

By segment, in Industrial Products Group, year-over-year orders were up 11%, including nine points from Robuschi and one point of FX headwind resulting in a 3% organic growth rate. As expected, this segment's growth rates continue to moderate versus prior year as all three regions, North America, Europe and Asia-Pac including China, experienced single-digit year-over-year growth rates in the quarter.

In terms of revenue, IPG revenues increased 14% to $326 million, 8% organically as our business outside of Europe grew double-digits year-over-year offset by mid single-digit growth rates in Europe. A number of regions stood out as we had very strong performance in our Americas business, up approximately 15% year-over-year and Asia-Pac up in excess of 40%. China grew in excess of 10% year-over-year.

Our EPG orders were up 12% year-over-year, up 13% organically to $323 million and sequentially, EPG orders improved 78% versus the fourth quarter of 2011. We saw a good growth in our later cycle EPG businesses, such as, Nash and Emco Wheaton and loading arms, both up double-digits as we booked some large orders for delivery in late 2012 and early 2013.

EPG backlog as of 3/31 is $464 million, up 18% year-over-year. This includes pressure pumping obviously, and as you know, recent pressure pumping market conditions have changed. And we are proactively working with our customers to get a realistic view of the backlog as well as shipments for the balance of the year.

In an attempt to put pressure pumping discussion in the context of the broader Gardner Denver picture, we've decided to provide some high-level information on what we refer to as our Petroleum & Industrial Pumps business or P&IP. P&IP represents approximately 19% of 2011 revenues or about $450 million in 2011.

One-third of our Petroleum and Industrial Pump's revenues or approximately $150 million is our drilling pump or mud pump business, which we sell to long-standing customers like, Helmerich & Payne. This business is looking well, and typically grows in line with rig count, which we're modeling at an average of 1900 going forward.

The remaining roughly two-thirds or $300 million of revenue is what we internally call well servicing, which sells OEM pressure pumps, fluid ends and provides repairs to the industry. Our pressure pumping business was about 13% of revenues in 2011, split evenly between OEM pumps and aftermarket.

We've been a leader in the pressure pumping business since 1988 and have been strategically focused on servicing the needs of some of the largest customers such as Baker Hughes and Schlumberger. Over the last two years, we’ve benefited tremendously from the boom in shale gas, but we've always known that the energy equipment business was cyclical. As a result, we focus on large well-capitalized customer that can handle the cycles, and we've invested in the aftermarket services for fluid end repair because that business is historically less cyclical than OEM pumps. In fact, very little, if any, of our capital expenditures in this segment have been targeted at OEM pump production as we use the principles of the Gardner Denver way to increase assembly capacity.

When we put together the plans for 2012, our view of pressure pumping was based on the data available to us at the time which included strong incoming order rates. Recall that our fourth quarter orders were up 40%, including a record backlog, positive customer discussions and our own analysis and third-party research reports. And then the February guidance we gave two months ago assumed OEM pressure pump shipments to be about flat in 2012.

Since then natural gas prices have continued to decline and market conditions have changed significantly. Research reports that were calling for a 35% increase in pressure pumping equipment in additional to the industry six months ago, last week projected a 32% decline in pressure pumping equipment in 2012, anticipating a deceleration in capacity additions in the back half of the year.

So the pressure pumping dynamics are obviously changing very rapidly and in light of recent customer announcements and discussions with our customers, we now expect a decline in OEM pressure pumps in the second latter part of the year, following a 75% year-over-year increase in shipments in the first quarter of 2012 and a nice increase in the second quarter as well.

For competitive reasons, we are not going to discuss in greater detail our operating margins or the specific growth rate assumptions for OEM pumps and aftermarket. Obviously, it's this up-stated view that is reflected in our updated guidance today.

Now, like I said, Gardner Denver has been in the energy business for a long time and we’ve managed through cycles before and the team is now focused on the things that we can control. Let me give you some examples of that.

First, our Petroleum & Industrial Pumps business is already a main business. Our fixed cost is measured by SG&A as a percentage of sales is less than 2%, and our headcount in well servicing is less than 350. The majority of our headcount is in US based non-union environments. So while it is always a difficult decision should we have to, we have the flexibility to adjust headcount to market conditions as needed.

Second, in this industry long standing customer and supplier relationships matter, and we're staying close to our customers and we're having constructive dialogues with customers who have indicated the desire to reschedule shipments, change orders or a last resort cancel previous orders.

Our former cancellation to date are less than 2 million, but our guidance today includes our best estimate for pumps being pushed out or canceled through the balance of the year. In parallel, we are actively working with our suppliers to reduce and in some cases stop the inflow of material. We do not have any take and pay agents in this business and obviously we're actively working to reduce our inventory levels as a top priority.

In addition we're in-sourcing the machining and production of things like aftermarket parts. Though we had outsourced in prior years as a strategy to be able to mitigate the impact of cycles. We are now able to absorb this production and keep a mine at a much lower cost.

In summary, we're dealing with a challenging and very dynamic situation, one that we've been through before and we're doing our best to stay focused on the things that we can control and mitigate the downturn in the pressure pumping business in North America.

With that, let me shift gears to talk about margins in the first quarter of 2012 and what we're doing across Gardner Denver to reduce costs in a moderating growth environment particularly in Europe. Adjusted operating income in the first quarter 2012 was $103 million; a 16% increase over last year as operating margins improved 40 basis points to 17%.

While EPG margins expanded 110 basis points to 24% in the first quarter, we're not satisfied with the pace of margin expansion in IPG, as IPG margins in the quarter were 11%, down 30 basis points year-over-year. This is primarily driven by a mix change in the Americas and Robuschi startup cost. I'm happy to say that Robuschi performed the budget in March and will contribute positively to our margin expansion initiatives in the second quarter and beyond.

As a result, we've intensified our efforts on focus on restructuring in Europe, and yesterday announced Phase 1 of a global restructuring effort after booking $15.5 million charge in the first quarter.

The first phase of this restructuring is primarily focused on Europe and will reduce our global headcount by approximately 350 employees or 5% with an anticipated payback of less than 24 months.

The Phase 2 of this plan is a two to three year program focused on further structural cost reductions, as we plan to reduce the number of IPG sites in Europe by a minimum of 50%, and our global employment by another 5% by the end of 2013.

Like we did last quarter, our updated 2012 guidance only includes the restructuring already announced, but you should expect to see restructuring charges in the second quarter and throughout the year, as we finalize, announce our plans globally, and aim for a two year or better payback on these programs.

In order to compete globally, we not only have to reduce our cost, but we have to focus on simplifying the business on how we go to market and in the quarter, we launched our new program called One Gardner Denver to simplify the way to go to market, reduce our selling costs and implement information systems that give us better visibility all the way to the end customer.

After spending two weeks in Europe, I've launched One GDI which will revolutionize the way we go to market. As you know GDI was built upon a number of very successful acquisitions with very good brand recognition.

What we have yet to do is to bring the entire portfolio together as one company in the eye of the customer. There is not a single company on the planet that has the ability to provide products from the highest of pressures to lowest of vacuums, with one exception, Gardner Denver. We will change the way we go to market by instituting a distribution base that can represent all of our Industrial Products with one phase to the customer.

This will take time as we have many tasks to accomplish, particularly from an information systems standpoint. But be certain that we are resolute about this and will be deploying our best global talent to the continent to enable the strategic change.

We have instituted a small pilot in Eastern Europe and preliminary indications are that this will be a great success. Let me leave this topic with one bit of data that should enable you to cite the opportunity.

In the Americas, our revenue for a employee is about 60% higher, than in Europe where our headcount in IPG is close to 2,400. Let me spend a minute on capital allocation. Given our revised outlook, we've decided to revisit and reprioritize our CapEx budget for the year, targeting at 10% reduction from budget to about $50 million.

In addition, while the acquisition environment remains active, multiples for strategic deals remain elevated in the slowing growth environment with plenty of uncertain globally. As you can imagine, this represents a real challenge for disciplined buyers. We view repurchasing our stock at current levels as very attractive and significantly lower risk and cost.

The third point I wanted to cover today was an update on the organization. Since I got here in '08, we worked on strengthening the organization team here at Gardner Denver and we've been able to attract some great talent to drive cash and earnings growth and lead the implementation of the Gardner Denver way.

Brian Cunkelman, our new Vice President of IPG is a great example of that. Brian has 17 years with Wabtec, a company I know well, and many more years with Gardner Denver, his first two years of Gardner Denver were running the IPG's Americas business and more recently, in Europe, running the Emco Wheaton business and getting an understanding of IPG. I was very pleased to announce his promotion to Vice President of IPG. Brian has a strong track record as an operationally-focused leader and is a great fit for this role. In addition, he will remain based in Europe and is already fully engaged in our restructuring efforts there.

In addition, we are promoting three leaders in EPG to direct reports to me as Duane Morgan; he turned 63 this year, retires effectively May 2012. Duane has made terrific contributions to Gardner Denver in the EPG business in terms of organic growth and margin expansion over the past seven years. I'd like to thank him for his leadership and for driving the Gardner Denver Way in the Engineered Products Group and also welcome three new leaders to our senior management team.

Let me tell you a little bit about the three additions. Larry Kerr is a 22-year Cameron alumnus, who joined us over three years ago as Vice President and General Manager for our Petroleum & Industrial Pumps business. Mark McElhinny he is a five-year Danaher alumnus, who joined us in 2009 as Vice President and General manager of our Thomas business, and last but not least, Vince Trupiano who joined us from just around, about two years ago following a career of leadership roles at United Technologies and Ford and will continue to provide strong leadership as Vice President and General Manager of our Nash business.

I view these transitions and promotions as normal course of business and I am convinced that these leaders have what it takes to continue to drive the Gardner Denver Way throughout our culture and deliver on our commitments to customers, shareholders and employees.

Finally, turning to our outlook for 2012, we've obviously had the same macroeconomic conditions as everyone else. As growth rates are moderating especially in Europe and to some extent in emerging markets. There are some positive signs in the US as evidenced by recent improvements in industrial production and capacity utilization. We have a strong backlog in the EPG and good momentum in our later cycle business. Internally, we have a renewed focus on our margin expansion efforts in IPG and we have the intensity and leadership across the business and we remain committed to achieving 14x14 in IPG and accelerating our margin expansion efforts in 2012. We believe that versus our February guidance, we can manage to puts and takes across the business excluding the rapid changing environment and pressure pumping particularly in the second half of the year.

Therefore, we're lowering our total year guidance for 2012. I'll remind you that there is obviously still some uncertainty around these assumptions. We now anticipate that adjusted diluted earnings per share for 2012 will be approximately $5.60 to $5.80, up 2% to 5% over 2011 and down $0.40 from the midpoint of our previous guidance. We estimate that our second quarter 2012 adjusted diluted earnings per share will be in the range of a $1.40 to $1.50, up 4% to 11% over the second quarter of 2011.

The full-year guidance excludes profit improvement initiatives and other items totaling $0.405 for the second quarter, resulting in guidance on a GAAP basis of $5.20 to $5.40 for the year and a $1.35 to $1.45 for the second quarter of 2012.

The financials are off to a great start of the year, but we have to face the reality and stay focused on the things that we can control to drive cash and earnings growth. First and foremost, margin expansion as we decisively restructure the business.

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

Michael M. Larsen

Thanks, Barry. Let me give you some additional detail in a couple of areas. First, we continue to make good progress on SG&A, as SG&A as a percentage of sales was 17.5%, down 50 basis points from prior year as we maintain good cost controls. If you take out the acquisition impact, our SG&A comps were up 1% year-over-year as revenues grew 14%.

In the quarter, foreign-exchange impact was not significant on a year-over-year basis and in line with our February guidance. Our guidance for the balance of 2012 assumes current exchange rate, which on a year-over-year basis creates about $0.06 of various headwind for the balance of year, four of which is in the second quarter of 2012.

Our effective tax rate in the first quarter was in line with our expectations and previous guidance at 29%, and while the rate can fluctuate on a quarterly basis, we expect our tax rate to remain in the 29% range for the balance of 2012.

On the balance sheet, operating working capital defined as a net of inventory receivables and payable accrued liabilities was 16% of sales in the first quarter, up slightly from the first quarter of last year. Working capital improvement, especially inventory remains a top priority, and we expect to see solid cash generation going forward.

As of March 31, 2012, we had approximately $187 million of cash on hand, and total debt was $404 million, resulting in a debt to capital ratio of 23%, down from 24% at the end of 2011, giving us plenty of flexibility in terms of capital deployment.

Depreciation and amortization was $19 million for the quarter, and we expect $66 million for the full year. Operating cash flow was $49 million in the first quarter, up 2% from the first quarter last year and at 89% of net income.

We had two adjustments to operating income in our first quarter results, driven by restructuring and Robuschi-related purchase accounting adjustment and these items are also described in last night's press release on Page nine.

First, as expected and included in our February guidance, the amortization of the fair market value adjustments to backlog and inventory that were a result of the purchase accounting to Robuschi, led to an expense of $7.4 million or about $0.10 a share. This now completes the Robuschi purchase accounting adjustments. Second, the $15.5 million Phase one restructuring charge or about $0.22 in terms of earnings per share.

We do not expect to see significant benefits from these projects until 2013, and we anticipate that there will be additional restructuring charges as Barry said as we go through 2012. Since these projects are not finalized though, they are excluded from our guidance today in line with what we did in our previous guidance.

Last but not least, let me give you an update on our stock buyback program. In the first quarter, we spent $8.8 million on buying back 124,000 shares at an average price of approximately $71, which more than offset our creep of approximately 82,000 shares.

As of today, $100 million, approximately 1.6 million shares, remain under the current share buyback authorization from our Board of Directors. We believe that given our current stock price, utilizing this authorization to buyback the stock makes a lot of sense for our shareholders, especially when you compare the financial impact of a stock buyback program to the elevated multiples received for potential acquisitions.

Paying double-digit multiples on EBITDA for acquisitions when Gardner Denver stock is trading at 67 times EBITDA is difficult to rationalize. That said, we've historically been an acquisitive company and that has generated significant shareholder value over time and will continue to be an acquisitive company, but also a company that remains balanced and disciplined in terms of capital allocation.

I should point out that further stock buybacks are excluded from our guidance today. With that I'll turn it back over to Barry. Barry?

Barry L. Pennypacker

Thanks, Michael. Before I open up for questions, I'd like to say that the year pretty much started out as I expect. I'm particularly excited about the management team we've assembled here, and I'm generally pleased with the first quarter results.

I think you can conclude from Michael's and my comments, that we have a fine-tuned focus on productivity of our fixed assets, working capital assets as well as our human capital to drive accretive results in the future.

Rest assured, this team is taking into account, any of the external factors that are currently available to us, that are affecting the business and by utilizing the principles of the Gardner Denver way, led by innovation and velocity, we will continue to execute and deliver against all of our plans to continue to add long-term shareholder value.

That concludes our prepared remarks, now I'd now to open it up for questions. I'll turn it over to you, Rob.

Question-And-Answer Session

Operator

Thank you. We’ll now be conducting the Question-and-Answer session. (Operator instructions). One moment please as we pause for questions. Thank you. Our first question is from the line of Jim Lucas with Janney Capital Markets. Please proceed with your question.

James Lucas - Janney Capital Markets

Thanks, good morning guy? First question, Michael, quick housekeeping. What was CapEx in the first quarter?

Michael M. Larsen

$13 million.

James Lucas - Janney Capital Markets

$13 million, great. Thank you. Barry, if you take a step back and look at IPG, the progression of the margin expansion that you had enjoyed in early on and kind of hitting the plateau here, besides the structural issues in Europe, as you've assessed IPG, can you talk about what specifically the drivers in the margins are that can get it back on track besides the European restructuring?

Barry L. Pennypacker

Yeah, Jim, good question. We still are in the very early throes of taking advantage of our low cost sourcing activities. We've got great focus around it. As I've said, I brought in a person that worked with me in the past. He’s built a very solid team. We're expecting fantastic results in the second half of this year, and the programs that we've looked at, I believe will get us back on track to show the steady progress that we need to demonstrate 14x14.

Keep in mind the restructuring activities that I mentioned today are an enabler for us to go beyond 14x14. Good productivity improvements that we need to make still in some of the areas of the business, some structural change that we need to do in Europe, coupled with the activities that our sourcing team will bring to us, the second half of this year, the first half of next year. You should see steady progression in the margins. Now, will we get 150 basis points this year? I don't think you should count on that. And let me tell you why. We have a lot of moving parts in Europe this year as we began this restructuring program. I am convinced that we will continue as our capital investments and productivity improvements in a Gardner Denver way. Activities that we measure will see steady progress internally on those margins, but you can't expect to take 350 people out of a region upwards of 25% of the headcount in a short period time as well as begin a substantial restructuring effort and expect productivity improvements in the largest region.

So we're aware of that, we're focused on that, we're not letting the balance of the world off of the hook. We will get margin expansion and that will come from other areas in the world. I mentioned in my prepared remarks a little bit about Robuschi. We had a rough start to the year in Robuschi, a lot of it I think was self-inflicted. But as I said, I believe and I know that in March we were back to our modeled operating earnings percentage and I know that that will contribute to our margin expansion activities in the second and third, fourth quarter this year.

James Lucas - Janney Capital Markets

Could you expand on that self-inflicted issue with Robuschi?

Barry L. Pennypacker

I mean, you know Robuschi is a family-owned business and you know the systems that they have in place, the controls that they had in place – as a publicly-traded company, we had to go in and we have to make sure that we have the controls that are consistent with Sarbanes-Oxley and we had to put controls in place and it was a tough transition. We basically stopped the business for a period of a couple of weeks to make sure that we were confident that the way inventory was transacting and the way that payables were transacting were consistent with the Gardner Denver way.

James Lucas - Janney Capital Markets

Okay. That’s helpful. And then within IPG you've talked about the US and Europe. Can you talk about what you're seeing in Asia? Last quarter you talked about launching The Dragon and then expanding beyond that, any updates on new products?

Barry L. Pennypacker

Yeah, the Dragon is doing extremely well. We're on to the third frame size, and I think that will continue to bode well, not only in the region of China, but outside of China in the developing countries. Our new product development – before I get to new product development, other areas that are showing very good growth for us in Asia-Pac is the what we call Engineered Systems Group. You'll hear more about that as we go forward, because we believe it's a great opportunity for us to take all the Gardner Denver products together and bundle them in foreign business unit that can approach this offshore market in particular with FPSOs, with everything from blowers to compressors to drilling pumps. So, that's a great opportunity for us. It continues to develop.

With regards to innovation, we're doing a lot of great things. You'll hear some news next week about a project called Air Innovations; that is something that we've launched – we'll be launching next week to our distribution base, and I think you'll find that, that new product will drive some substantial growth. We continue to look at ways to become more efficient in our drilling pumps, in our fracking pumps, and continue to introduce innovations and aftermarket parts to drive growth.

An interesting area to mention is the amount of attention that currently the PZ-2400 pump that we recently introduced is getting. The longest lateral drilled in the Bakken shale over the course of the last five years was just completed a month ago and that was completed with the PZ-2400 Pump, the company that was drilled for I met last week, he was very complimentary about the pump and very excited about the ability of the PZ-2400 Pump to give them a strategic advantage through going through longer laterals. So, innovation is alive and well, continues to be on the forefront of everything we do and the one area that if we can do a little better in is the velocity within the innovation projects.

James Lucas - Janney Capital Markets

Great. Thank you very much.

Operator

Thank you. Our next question is from the line of Jeffrey Hammond with KeyBanc. Please state your question.

Jeffrey Hammond - KeyBanc

Hi, good morning guys. Just a couple of things on the guidance, I just want to understand better some of the moving pieces. So, first on pressure pumping, I know, for competitive reasons you didn’t want to give too much color, but if you were expecting flat for the new frac pump business, I mean what are we expecting on a full year basis for the frac pump business now? And maybe within the $0.40, how much is frac pump versus anything else?

Michael M. Larsen

Yeah, let me just say that the adjusted guidance today, the $0.40 from the midpoint of the previous guidance that we've taken out is entirely related to pressure pumping. So, when you run through the year, there is typically some puts and takes across our business units and we're comfortable that we can manage those. But what we're not able to manage is the rapid change in pressure pumping, that Barry talked about. So the entire $0.40 is coming out of pressure pumping. And predominantly, it is a decline in the second half on OEM pressure pumps and we really don't want to go much further than that, but we also did tell you that in the first quarter our pump shipments were up 75%. So, when we talk about the data available to us in February when we gave guidance, that was what we were looking at that time. Cleary, things have changed and we now expect a decline in pumps in the second half. But breaking out the detail between the assumptions, specifically for pumps versus fluid ends versus repairs, which we don't talk a lot about, we're just not going to do, Jeff.

Jeffrey Hammond – KeyBanc Capital Markets

Okay. And then just can you give us a sense – you gave some good color on IPG margins and some of the moving pieces. Can you give us a sense of what you're building in for IPG margins within the guidance?

Barry L. Pennypacker

You mean for EPG margins?

Jeffrey Hammond - KeyBanc Capital Markets

No. IPG.

Barry L. Pennypacker

Basically Jeff, with all the moving pieces that we have with the restructuring, we're building flat.

Jeffrey Hammond - KeyBanc Capital Markets

Okay, great. And then just final question on cap allocation, I think you said you're going to shift more to buy back and those aren't in the guidance. But it looks like you have about at current prices $90 million to $100 million of buyback. It seems like you're going to generate something closer to free cash flow, $250 million. So does the balance go to acquisitions or we get a re-up at some point on the buyback?

Barry L. Pennypacker

We have a Board Meeting coming up here in three weeks and I will be more than anxious to discuss with the Board another potential buyback.

Jeffrey Hammond - KeyBanc Capital Markets

Okay. Thanks guys.

Operator

Thank you. Our next question is from Mike Halloran of Robert W. Baird. Please state your question.

Michael Halloran - Robert W. Baird

Morning guys. So you spent a lot of time in the prepared remarks talking about the OE side and the pressure pumping business. Could you also maybe give some color on the aftermarket side? That's a little bit more broad based activity level base and you've got that nice recovering revenue to it. When you talk about the declines that the industry has talked about on the original equipment side, could you maybe put that in context for the aftermarket side as well, just on a qualitative level?

Barry L. Pennypacker

Well, we continue to believe that year-over-year we'll see growth in the aftermarket. We have some internal programs that are affecting – that will affect our ability to grow the aftermarket that I'm not willing to discuss this quarter, but I will be able to discuss next quarter. The activity remains strong and I think the – one of the reasons it remains strong for us is that through the cycle we've been an innovative company with fluid ends. We've got what we believe is a better mousetrap. Our customers believe that and they continue to give us orders for the future and look at the prospects for that.

Keep in mind that the capacity additions that we talked about were not centered around OEM pumps. They were centered after the aftermarket and we're going to be very aggressive in continuing to grow that. As you know, the aftermarket has margins that are better than the overall company average and we've invested heavily in that. We expect that there will be discipline in the market and we're going to go after it very heavily with new products and innovations and we're going to continue to try to grow our aftermarket through this cycle.

Michael Halloran - Robert W. Baird

Makes a lot of sense. And then on the loading arm side, Emco Wheaton business, could you just talk about the trends you're seeing there on a broad basis and what the quoting activity looks like on a broader basis?

Barry L. Pennypacker

Yes. Very good quoting activity and very good win rate. We've got some development activities with some of the bigger E&C firms that will really drive some great growth for us going into 2013. Not so much latter part of '12, but the early part of 2013. Quoting activity remains strong as FPSOs continue to be built. There is a substantial need for loading arms to aid them and I can say that we're very pleased with that business and we look forward to how it's going to help us mitigate any potential that could continue in North America with the overall pressure pumping business in the first half of 2013.

Michael Halloran - Robert W. Baird

Great. Appreciate the time.

Operator

Thank you. Our next question is from Kevin Maczka of BB&T Capital Markets. Please state your question.

Kevin Maczka - BB&T Capital Markets

Good morning. Barry, going back to IPG margins, it sounds like you're baking in a flat margin for the year into your guidance. Can you say a little bit more about the timing of these European savings that you expect to realize? You're going to – you've got 10 facilities there. I think you said you're going to close at least half of them and you've got a two year payback. But later this year should we expect to see some meaningful savings from that?

Barry L. Pennypacker

Well, you should expect to see this year savings from the $15.5 million restructuring program that we just announced. We have not given any notification to our employees and or have made final decisions on plants that are going to be closed. As we continue to evolve that strategy internally, we will in fact let you know which plants, what the timing is and when we can expect the returns. But for the short-term until we give you further data, model with $15.5 million at less than a two year payback.

Kevin Maczka - BB&T Capital Markets

Got it. That’s all I had. Thank you.

Operator

Thank you. Our next question is from Josh Pokrzywinski of MKM Partners. Please state your question.

Joshua Pokrzywinski - MKM Partners

Hi. Good morning guys. Couple of questions. First on EPG, on the aftermarket side. Obviously with some of that equipment getting moved around in the field, they can imagine that the utilization rates are a little more sluggish in 2Q. Any reflection you guys – I know you don't want to quantify anything, but do you guys contemplate kind of an air pocket or any deceleration in aftermarket as some of that equipment is moving around or are you seeing that in the business at all?

Barry L. Pennypacker

Josh, the way to answer that question is that if in fact we told you that we were – half of the business was OEM production and half was fluid ends, then I would tell you that I would expect some issues, but that's not what we told you. We told you that that business is comprised of OEM pumps, aftermarket parts and repairs. The Fort Worth facility that we invested a substantial amount of our capital end over the last 12 months is extremely busy. During this lull, what is happening is people are rebuilding their frac fleets and that bodes very well for our Fort Worth facility where people instead of buying new pumps, are taking their own pumps and sending them to us in Fort Worth and having us rebuild them. Now it's true that when we rebuild the pump, 95% of the time it will be a new fluid end put on there. So the capacity that we built over the years for increased fluid end production, will certainly help this lull in aftermarket parts through our repair activities in Fort Worth.

Joshua Pokrzywinski - MKM Partners

Okay, that's helpful. And maybe thinking about and again I understand, you don't want to get too specific, but do you have any expectation that there will be price softness? Obviously as volumes were off you have a big competitor in Texas who it sounds like has invested a bit more in both headcount and physical footprint that may use a little discipline, or at least we don't know enough about given a limited ownership. Any sign that prices is eroding at all or any expectation for that built in the guidance?

Barry L. Pennypacker

No, there is no signs and no, we haven't built in any price degradations into our guidance. I think this is – as I said, it is a different market. I think there's a lot of discipline around this. This is a temporary I believe lull in pressure pumping in the U.S. It's not a permanent cyclical downturn, but I expect discipline and we have not built any price reduction into our guidance.

Joshua Pokrzywinski - MKM Partners

Okay, that's helpful. And then one last one from me on IPG. Maybe I misunderstood, you mentioned 14 by 14 in the prepared remarks and then this $15 million coming within two years. If it were incremental, it sounds like we are talking more about 15 by 14. Is this a required step in 14 by 14 or should we think of what's going on in Europe as shifting the bar beyond that?

Barry L. Pennypacker

There are two ways to think about it. I would tell you that a portion of that is due to the downturn that the European zone is in fact experiencing. But the lion's share of that particular restructuring activity is to get us beyond 14 by 14.

Joshua Pokrzywinski - MKM Partners

Okay. What would you expect the timeframe is on being able to quantify that? You made it sound like there are more phases to be announced over the coming quarters. Should we expect an update this year?

Barry L. Pennypacker

Every quarter you should expect an update.

Joshua Pokrzywinski - MKM Partners

Okay. Thanks a lot guys.

Operator

Thank you. Our next question is from Julian Mitchell of Credit Suisse. Please state your question.

Charles Clarke - Credit Suisse

Hey guys. It's Charlie for Julian. I appreciate the color today on the pressure pumping business and with everything else. I think most of the questions that I had written down have already been answered. But I guess just given the rapid changing dynamics that you guys have talked about just in pressure pumping and the abundance of new competition that we've heard about, I guess in the past 12 months felt like the gold rush, just kind of the growth rates have attracted some entrants. And Barry, I've heard you talk about it before, but just wondering, what's in the plan to protect the margins just going forward? Just like you guys said, shipment is up 70% in the first quarter.

Other people are probably seeing that too. Probably maybe a little bit too much inventory in the channel. So I think people are – investors and people that I talk to are really worried about pricing and maybe like a lack of technology on the fluid end side. So you've always told us that execution – a guy call me on Friday for fluid end and I can deliver it to him the next day on Saturday and making sure that it's there. That's important to you guys and important to the customer. So just wondering, how do you guys plan on protecting your pricing and your margins and is it execution, is it technology, et cetera?

Barry L. Pennypacker

The one thing I can't protect is pricing, correct? If there are people out there who have invested a machine tool and decide to take a hit on pricing and drive the market down, I don't think that's going to happen, but should that happen I can't control that. The thing I can control is our ability to have quality fluid ends that perform, the best delivery and quite frankly the best performance. And then when you get beyond quality, delivery and performance there is one left and that's called cost. And I think you'll see if you go back and listen to some of the remarks that I made and analyze some of those remarks, I think you'll see that we have a better mousetrap.

We have the ability to in-source things that we've had outsourced over the course of this run-up, which will give us the opportunity to significantly reduce our costs. So should in fact there not be discipline in price, we have no excuse to still have margin reduction. We will execute internally via the Gardner Denver Way, via our low-cost sourcing, via our innovation to continue to protect the margins in this wonderful part of our business.

Charles Clarke - Credit Suisse

Okay, thanks. And then just on the IPG side, just speaking with you, you've always told us the big difference if you look at best-in-class, somebody like in Atlas Copco, their compressor technique business and you see margins there are low 20s and you've always said, one of the biggest differences in the margin there is that distribution channel, and just running some math, just on their business that runs through distributors versus yours and trying to adjust for that, it seems to me like theoretically, longer-term that the IPG margins could be significantly higher. Is a lot of that– aside from the distribution channel and the OE aftermarket mix, what are some of the other puts and takes? Is it really just your footprint? How you talked about taking the number of sites where you're producing down 50%? Is it revenue per head or are there some other puts and takes that explain that?

Barry L. Pennypacker

Again I think if you go back and analyze this transcript, you'll be able to take some data and do some calculations and be able to get to some of those types of numbers that you're talking about. We have to reduce our footprint. We have way too much footprint. Every country that we have in Europe will have multiple SSDs. We've had an Elmo Rietschle facility that had six people in it. We've had a CompAir facility that had six people in it. We'll have a Bottarini office that had two people in it. We'll have a Robuschi office that will have four, five people in it. We need to understand what that's all about. We need to consolidate that and while we're consolidating it, we need to have one face to the customer. There is not a single company in this world that can go from the highest of pressures to the lowest of vacuums, and I have not been in a single manufacturing plant in the world yet where I have not seen a need for the highest of pressures and the lowest of vacuums.

And we are launching one GDI to be able to go out and approach this, find a distribution base that's willing to make the investment, because it's going to take an investment. We're willing to train them. And as I said, we have a pilot underway in Eastern Europe that is proving to be very successful. When you are a large manufacturing facility, the last thing you want to do when it comes to your fifth or sixth utility, which is air or vacuum, is to contact 26 different people. If you can do one-stop shop for vacuum and positive air pressure, you're going to have a very competitive case for margin expansion and that's exactly what we plan to do. But along with the way we go to market, we also have to adjust the footprint so that we have the lowest cost.

Charles Clarke - Credit Suisse

Thanks guys.

Operator

Thank you. Our next question is from Jamie Sullivan of RBC Capital Markets. Please state your question.

Jamie Sullivan - RBC Capital Markets

Good morning. I guess just to hit one on the pressure pumping business. So it sounds like the – at least on the OEM side the revenues will be up in the first half. You talked about it'd be slowing in the second half. Let's say it's down with the industry and the aftermarket holds up, it seems like you're assuming that the OE shipments largely go away in the back half, what seems like a relatively conservative assumption. So I was just wondering if you could comment on that and whether you feel like you’ve built in some contingency in your outlook for sort of further unanticipated trends in that market.

Michael M. Larsen

Jamie, this is Michael. The way we think about guidance hasn't changed. I mean we like to be fairly conservative, but also realistic in terms of the guidance we put out there and give ourselves the opportunity to potentially do better than that. And I think this – the guidance, the updated guidance today is no different from what we've done in the past in that respect.

Jamie Sullivan - RBC Capital Markets

Okay. Thanks. And then just on the IPG side, for Robuschi in the first quarter, how much of a headwind was it on an adjusted basis? Or how did margins in the core business trend year-over-year?

Michael M. Larsen

Yeah, I mean I think if you analyze the IPG margins, it doesn't take much to swing it by 10, 20 basis points here. So we are not going to break it out specifically for Robuschi. I think the important thing is that the distractions that may have taken place in January and February as we got our integration up and running in earnest and we freed up space in the plant and we trained everybody on compliance and controllership the Gardner Denver Way, those are done now and team in March rebounded nicely. And we expect – we told you last year when we did the acquisition that margins in this business are in the low 20s in terms of EBIT and we expect to get back to that level here through the balance of the year.

Jamie Sullivan - RBC Capital Markets

Okay. And then just lastly on the – I think you mentioned in IPG a mixed headwind in the U.S. Can you talk a little bit more about that? What kind of demand you're seeing that's driving it?

Barry L. Pennypacker

Yeah. If you look back last year and look at it year-over-year, which is what we're doing, the first quarter of last year had a substantial increase in what we call our mobile blower business in the U.S. and the mobile blower business in the U.S. is really the blowers that are being attached to Class A trucks that are used for things like blowing frac sand. As you know, there is a lull in the need for equipment in the fracking business in general and that affected our mix in the U.S. with regards to the overall margins. And the team did a great job of mitigating that, but that product really does have pretty good margins attached to it.

Jamie Sullivan - RBC Capital Markets

Okay, thanks very much. That’s all I had.

Operator

Our next question is from the line of Cliff Ransom with Ransom Research. Please state your question.

Clifford Ransom - Ransom Research, Inc.

Good morning gents. I was wondering if you could give me the EPS contribution from the four eastern most states of – counties of Texas?

Barry L. Pennypacker

Yeah, you got it.

Clifford Ransom - Ransom Research, Inc.

Get right to the details….

Barry L. Pennypacker

I'll get back to you on that one.

Clifford Ransom - Ransom Research, Inc.

Okay, that’s fair. Guys, I guess – why do you – you've used the phrase now the temporary lull in gas, Could you explain the use of that language for us? (Inaudible) but I'd like to make sure?

Barry L. Pennypacker

Let me be specific. I didn't say gas, I said fracking.

Clifford Ransom - Ransom Research, Inc.

Fine and that was going to be next question. Keep going.

Barry L. Pennypacker

All right. So temporary lull in fracking. Gas prices at $1.90 does not attract a lot of activity. Oil prices at $95 to $100 attract a lot of activity. There is a transition happening from gas to oil. Assets are being analyzed and understood where they're at. I was at an industry meeting last week for the Petroleum Equipment Suppliers Association. I talked to a number of CEOs of large independent companies that are very, very bullish on the second half of next year with regards to fracking in oil shales. What they don't know and what we have to understand is how much of a buildup of equipment has happened leading up to this anticipated need.

We've taken our best swing at a pitch and as you can see from the guidance we put forward, we have what we believe is a very realistic scenario going forward. But rest assured of one thing, barring a major faux pas coming out of Washington D.C., fracking is here to stay and the productivity that these particularly independents are getting with drilling longer and longer laterals, the productivity that they're getting, fracking is going to stay.

Operator

Our next question is from Joe Mondillo with Sidoti & Company. Please state your question.

Joe Mondillo - Sidoti & Company

Good morning guys. First question, just – I don't know if you gave this, but I was wondering if you could talk about just your organic growth in Europe, and if you could provide any growth rates in Europe, North America and elsewhere or at least talk about the organic growth in the geographic regions?

Michael M. Larsen

We're not really going to break it out further than we did in the script here, Joe, but what I'll tell you is that growth rates in Europe are in the low single-digits, which is kind of what we expected coming off of what was a record year last year. With all the fiscal and political uncertainty in Europe, that's what we're seeing. We don't expect it at this point to get a lot better than that, but we also don't expect it to get a lot worse than that. So I think, things have somewhat stabilized in Europe at low single-digit type growth rates.

Joe Mondillo - Sidoti & Company

Okay. So a lot of the macro indicators that we're seeing are showing continuing deterioration. You’re not seeing sort of a directional trending down type deterioration in your…?

Michael M. Larsen

Yeah, I think growth rates, they have moderated relative to last year. But it's not a rapid deterioration that we're seeing in our order rates, no. I don't think you saw that in the results we reported, right?

Joe Mondillo - Sidoti & Company

Right. And China remain stable compared to…?

Michael M. Larsen

Yeah, I think China also had single-digit year-over-year growth rate. I think it's fair to say when you look at the data that things are moderating in China and then revenues like we said grew in excess of 10% in the quarter.

Joe Mondillo - Sidoti & Company

Okay. And then I guess, the second question I had was just, if you could give us any update and sort of your thoughts on the international PIP market, what you're seeing there and sort of long-term timing and how and when you are going to benefit from maybe the Chinese shale reserves or anything related to that?

Barry L. Pennypacker

Yeah, we're continuing to evaluate that as our customers do. The European issues are still there. There are still a number of countries that have moratoriums on fracking. I think you've noticed in the last few weeks that Poland has loosened up some and continues to issue permits for new wells and I think that will bode well as we as an industry continue to gain confidence that this is alive and well and we are not causing earthquakes all over the place. And Eastern Europe will in fact loosen up. Western Europe is going to be a little bit longer. We continue to see a substantial amount of political pressure; very little relief in that. So we're not counting on that for the next three to five years.

China is a different story. China, we're seeing the service companies that we deal with starting to talk about deploying substantial resources to the region, and as they do that we'll be in a very good position to capture that business. Some of the products that we currently manufacture in China will fit very well into being able to help assemble and ship and service and make aftermarket parts for frac pump. So as that market continues to develop and the infrastructure is put in place, and as we all know, when the Chinese decide to put infrastructure in place it doesn't take very long. I think we'll see – originally we thought we'd see more activity out of the European region than we did in China. I think China will pass that.

Joe Mondillo - Sidoti & Company

Okay, great. Thank you very much.

Operator

Thank you. Gentlemen, we have another question from Cliff Ransom. Please state your question.

Clifford Ransom - Ransom Research, Inc.

Yeah, it’s Cliff. I’m sorry. I just got cut off so I left you hanging. I apologize. How agnostic are you with respect to drilling for oil, for gas and for gas and liquids?

Barry L. Pennypacker

Drilling, we're indifferent. We have no preference whether you're drilling for an oil well or for a gas well.

Clifford Ransom - Ransom Research, Inc.

Well, how about – we have a movement from gas to gas and liquids, number one. We have a movement to use more stages in existing wells. I'm trying to get a sense of where the puts and takes are as that well is developed and starts to produce?

Barry L. Pennypacker - President and CEO

A lot of it depends on which shale formation you're in. We have historically said that we are indifferent as to whether or not we're fracking in oil versus gas. It turns out that we do have a preference in different shale plays. In some shale plays, the shale itself is only an eighth of a mile thick, where the deposits are for oil and in other cases, it's a mile. And what we found is that we need less frac stages in some of these shallower shales and more frac stages in some of the thicker shales, but the industry experts that we've been able to talk to over the course of the last 30 days say at the end of the day what you're doing is you're fracking rock and as you frac rock, the rock in the Marcellus Shale might be a little less dense than the rock in the Bakken shale.

However, you're still fracking rock and you still need a substantial amount of horsepower to do that. The lull quite frankly, I believe is the industry trying to decide where these assets need to be deployed in order to get the best short and long-term gain. But fracking, as I said, I think from an OEM perspective, the horsepower that we're going to be putting into the market in the first half of the year will probably be suffice for the North American market for the next 12 to 18 months.

Clifford Ransom - Ransom Research, Inc.

And it's fair to say that the revenue and earnings – we know there is lots of shale all around the world that has not been exploited. The Middle East, in Brazil, lot to go in Poland, tons and tons in China, but none of that should be in our minds as investors anything before, say, 2013 in a meaningful way. Would that be a fair thing to say?

Barry L. Pennypacker

I think you go beyond '13. You go out to '16 and '17….

Clifford Ransom - Ransom Research, Inc.

Okay.

Barry L. Pennypacker.

Before it's meaningful.

Clifford Ransom - Ransom Research, Inc.

And then the last question is, are you at all worried that the accelerating work in Brazil – this maybe a political question that you don't answer on the phone, but the Brazilian shifting regulations on Brazilian content for equipment in some of these critical industries, particularly as you go to deep offshore formations. Is there a risk that Brazil will wind up slowing its own development because they don't have those assets domestically?

Barry L. Pennypacker

Again I think there is always that risk. But as you know the Brazilians have been very resolute in where they can't get the technology within the country, there's ways to get it into the country without the political ramifications that some of us face on some of the products that we would try to ship in there. What bodes well for Gardner Denver is we have a substantial facility in Campinas, Brazil that can manufacture very large parts and I think is very well positioned to in source as the country continues to develop its E&P program, in-source some of the products that we currently manufacture here in the U.S. into that region.

We've been very successful in large liquid ring pump manufacturing in Brazil for the market, particularly in mining. And I believe that team down there and the facility has the capability to manufacture mud pumps should it be necessary and or frac pumps.

Clifford Ransom - Ransom Research, Inc.

Okay. So just to make sure I heard you right, this is my last question. You believe that you have the space, the talent in Campinas to be able to put that, whatever production equipments you'd need to make different kinds of products including large things would fit the oil and gas area.

Michael M. Larsen

Yeah, absolutely. No question about it.

Clifford Ransom - Ransom Research, Inc.

Thank you very much. I appreciate you putting me back on the call. Thanks.

Operator

Thank you. Ladies and gentlemen, we've reached the end of our allotted time for question-and-answer session. I'll turn the floor back to management for closing comments.

Michael M. Larsen

Thank you all for the insightful questions that you asked and we look forward to talking to you very soon.

Operator

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

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