Description
Filed with the SEC from July 26 to Aug 01:
Gardner Denver (GDI)
ValueAct Capital recommended that the company pursue a sale following the recent sudden departure of its CEO.
In a July 26 letter, ValueAct called a sale "both prudent and the most effective way to deliver maximum value to shareholders on a risk-adjusted basis for both the short- and long-term." It said its recommendation comes "in light of the circumstances in which [Gardner Denver] finds itself after the surprising resignation of its CEO, Barry Pennypacker, on Monday, July 16, 2012."
BUSINESS OVERVIEW
Executive Overview
Gardner Denver designs, manufactures and markets engineered industrial machinery and related parts and services. The Company is one of the world’s leading manufacturers of highly engineered compressors and vacuum products for industrial applications. Stationary air compressors are used to pressurize gas, including air, in excess of 50 pounds per square inch gauge (“PSIG”) and are used in manufacturing, process applications and materials handling, and to power air tools and equipment. Blowers and liquid ring pumps compress gas, including air, up to 50 PSIG and are often used in vacuum applications. Blowers are used primarily in pneumatic conveying, wastewater aeration and engineered vacuum systems. Liquid ring pumps are often sold as part of an engineered package and are used in process applications such as power generation, chemical processing and oil and gas refining. The Company also supplies pumps and compressors for original equipment manufacturer (“OEM”) applications such as medical equipment, vapor recovery, printing, packaging and laboratory equipment.
Additionally, the Company designs, manufactures, markets, and services a diverse group of pumps, water jetting systems and related aftermarket parts used in oil and natural gas well drilling, servicing and production and in industrial cleaning and maintenance. The Company also manufactures loading arms, swivel joints, couplers and valves used to load and unload ships, tank trucks and rail cars. The Company is one of the world’s leading manufacturers of reciprocating pumps used in oil and natural gas well drilling, servicing and production, and in loading arms used in the transfer of petrochemical products.
The Company’s divisional operations are combined into two major product groups: the Industrial Products Group and the Engineered Products Group. Approximately 42% of the Industrial Products Group revenue is generated through distribution, approximately 39% is sold directly to the end customer and the balance is for OEM products. By comparison, approximately 60% of Engineered Products Group revenue is sold directly to the end user, approximately 31% is used in OEM products and the balance is sold through distribution.
For the year ended December 31, 2011, the Company’s revenues were approximately $2.4 billion, of which 53% were derived from sales of Industrial Products and 47% were from sales of Engineered Products. Approximately 39% of the Company’s total revenues for the year ended December 31, 2011 were derived from sales to customers in the United States and approximately 61% were from sales to customers in various countries outside the United States. Of the total non-U.S. sales, 51% were to Europe, 28% to Asia, 5% to Canada, 5% to South America and 11% to other regions. See Note 20 “Segment Information” in the “Notes to Consolidated Financial Statements.”
The Gardner Denver Way
The Gardner Denver Way encompasses the Company’s values and strategies for growth, and defines how it delivers value to its key stakeholders — customers, shareholders and employees. The Gardner Denver Way starts with the Company’s customers, who are at the center of everything the Company does. It focuses the Company on building strong value-added relationships with its customers by listening to them, understanding their needs and quickly responding with creative products and services. When the Company’s shareholders understand the value-driven relationship the Company shares with its customers, they continue to invest the resources the Company needs in order to grow.
The commitment of the Company’s employees to the goals and vision of the Gardner Denver Way enables the Company to use those resources to create a stronger company. By empowering the Company’s employees, the Gardner Denver Way engages the creativity of all employees to develop innovative products and services that meet the needs of the Company’s customers, to quickly recognize opportunities and to capitalize on them. Innovation and velocity are the core of the Gardner Denver Way — driving the Company’s differentiation from its competitors.
Significant Accomplishments in 2011
The strategic goals of the Company, guided by the Gardner Denver Way, are to grow revenues faster than the industry average, and to grow net income and net cash provided by operating activities faster than revenues. Gardner Denver’s five-point growth strategy is comprised of organic growth, aftermarket growth, innovative products, selective acquisitions, and margin improvement. To accomplish its strategic goals, the Company has acquired products and operations that serve global markets, and has focused on integrating these acquisitions to remove excess costs and generate cash. The Company has pursued organic growth through new product development and investment in new technologies and employee development. The Company believes operational excellence and internal process improvements will help the Company achieve its goals, with a focus on its three key stakeholders: customers, shareholders and employees. The Company focuses on the needs of its customers to strengthen these key relationships and empower employees to respond to customers’ needs in innovative and effective ways.
The Company’s significant accomplishments in 2011 included:
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As a result of continued operational improvements and cost reductions through application of the Gardner Denver Way, and year over year revenue growth, the Company realized significant expansion in operating income as a percentage of revenues in both the Industrial Products Group and Engineered Products Group. Total year revenues for the business rose to $2.37 billion and operating margins finished at 16.9%, both records for the Company.
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20% organic growth through leveraging Gardner Denver channels to drive sales, investing in high-growth market segments such as energy, medical, life sciences and environment, and further strengthening the Company’s presence in faster-growing geographic markets, such as Asia-Pacific and Brazil by providing a broader range of locally manufactured industrial products. Results include promising order rates in attractive end markets and regions for both the Industrial Products Group and Engineered Products Group.
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Generated $300 million in net cash from operating activities, which was in excess of net income, compared to $202 million in 2010. Uses of cash during 2011 included the repayment of $125 million of 8% Senior Subordinated Notes, investments in capital projects of $55.7 million, the acquisition of Robuschi S.p.A. (“Robuschi”) for $200.8 million, repurchases of common shares of $132.6 million, the buyout of interests in two joint ventures for $18.8 million, and payment of cash dividends of $10.4 million ($0.20 per common share). The Company’s cash balance of $155.3 million, financing alternatives and availability under its various borrowing facilities provide the flexibility to consider acquisition opportunities should they arise.
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Developed new products that incorporate the voice of the customer, provide differentiation from the competition and strengthen the Company’s position as a leader in innovation. Examples include the Hoffman Revolution centrifugal blower and the PZ 2400 drilling pump.
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Increased aftermarket revenues as a percentage of total revenues to approximately 32% in 2011 from 31% in 2010. This increase represents solid progress toward the Company’s long term goal of 40% to 45%.
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Reduced Selling General & Administrative expenses as a percent of sales to 16.7% for total year 2011, down 280 basis points from 2010 levels of 19.5%.
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Completed the relocation of the Company’s corporate headquarters to the Philadelphia, Pennsylvania area. This location provides the logistical advantages of a major metropolitan area and better accessibility to global customers, the Company’s operations outside the U.S., investors and a broader pool of local professional human resources.
Management believes the continued execution of the Company’s strategies will help reduce the variability of its financial results in the short term, while providing above-average opportunities for growth and return on investment.
Industrial Products Group Segment
In the Industrial Products Group, the Company designs, manufactures, markets and services the following products and related aftermarket parts for industrial and commercial applications: rotary screw, reciprocating, and sliding vane air and gas compressors; positive displacement, centrifugal and side channel blowers; and vacuum pumps, primarily serving manufacturing, transportation and general industry and selected OEM and engineered system applications. The Company also markets and services complementary ancillary products. Industrial Products Group sales for the year ended December 31, 2011 were approximately $1.3 billion.
Compressors are used to increase the pressure of gas, including air, by mechanically decreasing its volume. The Company’s reciprocating compressors range from fractional to 1,500 horsepower and are sold under the Gardner Denver, Champion, Bottarini, CompAir, Mako, Reavell and Belliss & Morcom trademarks. The Company’s lubricated rotary screw compressors range from 5 to 680 horsepower and are sold under the Gardner Denver, Bottarini, Electra-Screw, Electra-Saver, Electra-Saver II, Enduro, RotorChamp, Tamrotor, CompAir and Tempest trademarks. The Company’s oil-free rotary screw compressors range from 5 to 150 horsepower and are sold under the Gardner Denver , CompAir and Dryclon trademarks. The Company’s oil-free centrifugal compressors range from 200 to 400 horsepower and are sold under the Quantima trademark. The Company also has a full range of portable compressors that are sold under the CompAir and Bottarini trademarks.
Blowers are used to produce a high volume of air at low pressure or vacuum. The Company’s positive displacement blowers range from 0 to 36 PSIG discharge pressure and 0 to 29.9 inches of mercury (in Hg) vacuum and capacity range of 0 to 17,000 cubic feet per minute (CFM) and are sold under the trademarks Sutorbilt, DuroFlow, CycloBlower, HeliFlow, Robuschi, TriFlow, Drum, Wittig and Elmo Rietschle. The Company’s multistage centrifugal blowers are sold under the trademarks Gardner Denver, Lamson and Hoffman and range from 0.5 to 25 PSIG discharge pressure and 0 to 18 inches Hg vacuum and capacity range of 100 to 40,000 CFM. The Company’s side channel blowers range from 0 to 15 PSIG discharge pressure and 20 inches Hg vacuum and capacity range of 0 to 1,500 CFM and are sold under the Elmo Rietschle, Airgen and TurboTron trademarks. The Company’s sliding vane compressors and vacuum pumps range from 0 to 150 PSIG discharge pressure and 29.9 inches Hg vacuum and capacity range of 0 to 3,000 CFM and are sold under the Gardner Denver, Hydrovane, Elmo Rietschle, Drum and Wittig trademarks. The Company’s engineered vacuum systems are used in industrial cleaning, hospitals, dental offices, general industrial applications and the chemical industry and are sold under the Gardner Denver , Invincible , and Elmo Rietschle trademarks. The Company’s engineered systems range from 0 to 32 PSIG discharge pressure and 29.9 inches Hg vacuum and capacity range of 50 to 3,000 CFM and are sold under the Elmo Rietschle trademark.
Almost all manufacturing plants and industrial facilities, as well as many service industries, use compressor and vacuum products. The largest customers for the Company’s compressor and vacuum products are durable and non-durable goods manufacturers; process industries (petroleum, primary metals, pharmaceutical, food and paper); OEMs; manufacturers of printing equipment, pneumatic conveying equipment, and dry and liquid bulk transports; wastewater treatment facilities; and automotive service centers and niche applications such as PET bottle blowing, breathing air equipment and compressed natural gas. Manufacturers of machinery and related equipment use stationary compressors for automated systems, controls, materials handling and special machinery requirements. The petroleum, primary metals, pharmaceutical, food and paper industries require compressed air and vacuum for processing, instrumentation, packaging and pneumatic conveying. The Company’s blowers are instrumental to local utilities for aeration in treating industrial and municipal waste. Blowers are also used in service industries, for example, residential carpet cleaning to vacuum moisture from carpets during the shampooing and cleaning process. Positive displacement blowers and vacuum pumps are used on trucks to vacuum leaves and debris from street sewers and to unload liquid and dry bulk materials such as cement, grain and plastic pellets. Additionally, blowers are used in packaging technologies, medical applications, printing and paper processing and numerous chemical processing applications.
The Industrial Products Group operates production facilities around the world including six plants in the U.S., four in the UK, three in Germany, two in Italy, and one each in China, Brazil and Finland. The most significant facilities include owned properties in Quincy, Illinois; Sedalia, Missouri; Peachtree City, Georgia; Princeton, Illinois; Bradford and Redditch, UK; Bad Neustadt and Schopfheim, Germany; and leased properties in Tampere, Finland; Simmern, Germany; Ipswich, UK; Qingpu China; and Parma, Italy.
The Company has six vehicle-fitting facilities in six countries within Europe. These fitting facilities offer customized vehicle installations of systems, which include compressors, blowers, exhausters, generators, hydraulics, power take-off units, gear boxes, axles, pumps and oil and fuel systems. Typical uses for such systems include the discharge of product from road tankers, tire removal, transfer of power from gear boxes to ancillary power units and provision of power for electrical and compressed air operated tools. Each facility can offer onsite repair and maintenance or support the customer in the field through their own service engineers and a network of service agents. In addition, the Company has two service and remanufacturing centers in the U.S. that can perform installation, repair and maintenance work on certain of the Company’s products and similar equipment.
Engineered Products Group Segment
The Company’s Engineered Products Group segment designs, manufactures, markets and services a diverse group of pumps, compressors, liquid ring vacuum pumps, water jetting and loading arm systems and related aftermarket parts. These products are used in well drilling, well servicing and production of oil and natural gas; industrial, commercial and transportation applications; and in industrial cleaning and maintenance. This segment also designs, manufactures, markets and services other engineered products and components and equipment for the chemical, petroleum and food industries. Engineered Products Group sales for the year ended December 31, 2011 were approximately $1.1 billion.
Positive displacement reciprocating pumps are marketed under the Gardner Denver and OPI trademarks. Typical applications of Gardner Denver pumps in oil and natural gas production include oil transfer, water flooding, salt-water disposal, pipeline testing, ammine pumping for gas processing, re-pressurizing, enhanced oil recovery, hydraulic power and other liquid transfer applications. The Company’s production pumps range from 25 to 300 horsepower horizontally designed pumps. The Company markets one of the most complete product lines of well servicing pumps. Well servicing operations include general workover service, completions (bringing wells into production after drilling), and plugging and abandonment of wells. The Company’s well servicing products consist of high-pressure plunger pumps ranging from 165 to 400 horsepower. Gardner Denver also manufactures intermittent duty triplex and quintuplex plunger pumps ranging from 250 to 3,000 horsepower for well cementing and stimulation, including reservoir fracturing or acidizing. Duplex pumps, ranging from 16 to 100 horsepower, are produced for shallow drilling, which includes water well drilling, seismic drilling and mineral exploration. Triplex mud pumps for oil and natural gas drilling rigs range from 275 to 2,400 horsepower.
Liquid ring vacuum pumps, compressors and engineered systems, sold under the Nash trademark, are used in many different applications including gas removal, distillation, reacting, drying, lifting and handling, filters, priming and vapor recovery. These applications are found principally in the pulp and paper, industrial manufacturing, petrochemical, power, mining and oil and gas industries. Nash products range in capacity from approximately 10 CFM to over 20,000 CFM. These products are sold primarily through direct sales channels and agents. Gardner Denver operates five Nash service centers in North America, and one each in the Netherlands and Australia. The Oberdorfer line of fractional horsepower specialty bronze and high alloy pumps for the general industrial and marine markets was acquired as part of the Thomas acquisition. A small portion of Gardner Denver pumps are sold for use in industrial applications.
Through its Thomas operating division, the Company has a strong presence in medical markets and environmental markets such as sewage aeration and vapor recovery through the design of custom compressors and vacuum pumps for OEMs. Deep vacuum pumps are sold under the Welch and ILMVAC trademarks into the laboratory and life science markets. Other major markets for this division include the automotive, industrial and printing markets.
Gardner Denver water jetting pumps and systems are used in a variety of industries including petrochemical, refining, power generation, aerospace, construction and automotive, among others. The products are sold under the Partek, Liqua-Blaster and American Water Blaster trademarks, and are employed in applications such as industrial cleaning, coatings removal, concrete demolition, and surface preparation.
Gardner Denver’s other fluid transfer components and equipment include loading arms, swivel joints, storage tank equipment, dry-break couplers and tank truck systems used to load and unload ships, tank trucks and rail cars. These products are sold primarily under the Emco Wheaton, Todo and Perolo trademarks.
The Engineered Products Group operates twenty-two production facilities (including two remanufacturing facilities) around the world including twelve in the U.S., four in Germany, two in China and one each in the UK, Sweden, Brazil and Canada. The most significant facilities include owned properties in Tulsa, Oklahoma; Quincy, Illinois; Syracuse, New York; Ilmenau, Kirchhain and Memmingen, Germany; Boshan and Wuxi, China; Margate, UK; and Toreboda, Sweden, and leased properties in Houston, Texas; Monroe, Louisiana; Elizabeth, Pennsylvania; Nuremberg, Germany; and Oakville, Ontario.
Customers and Customer Service
Gardner Denver sells its products through independent distributors and sales representatives, and directly to OEMs, engineering firms and end-users. The Company has been able to establish strong customer relationships with numerous key OEMs and exclusive supply arrangements with many of its distributors. The Company uses a direct sales force to serve OEM and engineering firm accounts because these customers typically require higher levels of technical assistance, more coordinated shipment scheduling and more complex product service than customers of the Company’s less specialized products. As a significant portion of its products are marketed through independent distribution, the Company is committed to developing and supporting its distribution network of over 1,000 distributors and representatives. The Company has distribution centers that stock parts, accessories and small compressor and vacuum products in order to provide adequate and timely availability. The Company also leases sales office and warehouse space in various locations. Gardner Denver provides its distributors with sales and product literature, technical assistance and training programs, advertising and sales promotions, order-entry and tracking systems and an annual restocking program. Furthermore, the Company participates in major trade shows and has a direct marketing department to generate sales leads and support the distributors’ sales personnel. The Company does not have any customers that individually provide more than 5% of its consolidated revenues, and the loss of any individual customer would not materially affect its consolidated revenues. However, revenue is derived from certain key customers for the Company’s petroleum products and the loss or reduction of any significant long-term contracts with any of these customers could result in a material decrease in the Company’s future profitability and cash flows. Fluctuations in revenue are primarily driven by specific industry and market changes.
Gardner Denver’s distributors maintain an inventory of complete units and parts and provide aftermarket service to end-users. There are several hundred field service representatives for Gardner Denver products in the distributor network. The Company’s service personnel and product engineers provide the distributors’ service representatives with technical assistance and field training, particularly with respect to installation and repair of equipment. The Company also provides aftermarket support through its service and remanufacturing facilities in the U.S. and Germany. The service and vehicle fitting facilities provide preventative maintenance programs, repairs, refurbishment, upgrades and spare parts for many of the Company’s products.
The primary OEM accounts for Thomas products are handled directly from the manufacturing locations. Smaller accounts and replacement business are handled through a network of distributors. Outside of the U.S. and Germany, the Company’s subsidiaries are responsible for sales and service of Thomas products in the countries or regions they serve.
Competition
Competition in the Company’s markets is generally robust and is based on product quality, performance, price and availability. The relative importance of each of these factors varies depending on the specific type of product and application. Given the potential for equipment failures to cause expensive operational disruption, the Company’s customers generally view quality and reliability as critical factors in their equipment purchasing decision. The required frequency of maintenance is highly variable based on the type of equipment and application.
Although there are a few large manufacturers of compressor and vacuum products, the marketplace for these products remains highly fragmented due to the wide variety of product technologies, applications and selling channels. Gardner Denver’s principal competitors in sales of standard configurations of compressor and vacuum products which are included in the Industrial Products Group include Ingersoll-Rand, Sullair (owned by United Technologies Corporation), Atlas Copco, Quincy Compressor (owned by Atlas Copco), Kaeser Compressor, Roots, Busch, Becker, SiHi and GHH RAND (owned by Ingersoll-Rand). Manufacturers located in India, China and Taiwan are also becoming more significant competitors as the products produced in these regions improve in quality and reliability.
The market for engineered products such as those included in the Engineered Products Group is highly fragmented, although there are a few multinational manufacturers with broad product offerings that are significant. Because Gardner Denver is focused on pumps used in oil and natural gas production and well servicing and well drilling, it does not typically compete directly with the major full-line pump manufacturers. The Company’s principal competitors in sales of petroleum pump products include National Oilwell Varco and SPM Flow Control, Inc. (owned by The Weir Group PLC). The Company’s principal competitors in sales of water jetting systems include NLB Corp. and Hammelmann Maschinenfabrik GmbH (both owned by Interpump Group SpA), Jetstream (a division of Federal Signal) and WOMA Apparatebau GmbH. The Company’s principal competitors in sales of other engineered products and equipment are SiHi, OPW Engineered Systems, Civacon (owned by Dover Corporation), FMC Technologies, Schwelm Verladetechnik GmbH (SVT) and Gast (a division of IDEX).
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview and Description of Business
The Company designs, manufactures and markets engineered industrial machinery and related parts and services. The Company is one of the world’s leading manufacturers of highly engineered stationary air compressors and blowers for industrial applications. Stationary air compressors are used in manufacturing, process applications and materials handling, and to power air tools and equipment. Blowers are used primarily in pneumatic conveying, wastewater aeration and engineered vacuum systems. The Company also supplies pumps and compressors for OEM applications such as medical equipment, vapor recovery, printing, packaging and laboratory equipment. In addition, the Company designs, manufactures, markets, and services a diverse group of pumps, water jetting systems and related aftermarket parts used in well drilling, well servicing and production of oil and natural gas; industrial, commercial and transportation applications; and in industrial cleaning and maintenance. The Company also manufactures loading arms, swivel joints, couplers and valves used to load and unload ships, tank trucks and rail cars. The Company is one of the world’s leading manufacturers of reciprocating pumps used in oil and natural gas well drilling, servicing and production and in loading arms for the transfer of petrochemical products.
Since becoming an independent company in 1994, Gardner Denver has completed 24 acquisitions, growing its revenues from approximately $176 million in 1994 to approximately $2.4 billion in 2011. The Company has completed 3 significant acquisitions since 2005, namely Thomas, CompAir, and Robuschi.
In July 2010, the Company completed the acquisition of ILMVAC, a European provider of vacuum pumps, systems and accessories for research and development laboratories and industrial applications headquartered in Ilmenau, Germany. This acquisition was complementary to the Company’s Engineered Products Group product portfolio. The results of ILMVAC are included in the Company’s financial statements from the date of acquisition.
In December 2011, the Company completed the acquisition of Robuschi, a leading European-based producer of low pressure compressors and pumps and associated packages formerly headquartered in Parma, Italy. Robuschi provides a comprehensive range of vacuum pumps, positive displacement blowers and centrifugal pumps. These products are used in, among other areas, water and wastewater treatment, power generation, food applications and chemical processes. This acquisition was complementary to the Company’s Industrial Products Group product portfolio. The results of Robuschi are included in the Company’s financial statements from the date of acquisition.
In the Industrial Products Group, the Company designs, manufactures, markets and services the following products and related aftermarket parts for industrial and commercial applications: rotary screw, reciprocating, and sliding vane air compressors; and positive displacement, centrifugal and side channel blowers; primarily serving general industrial and OEM applications. This segment also markets and services complementary ancillary products. Stationary air compressors are used in manufacturing, process applications and materials handling, and to power air tools and equipment. Blowers are used primarily in pneumatic conveying, wastewater aeration, numerous applications in industrial manufacturing and engineered vacuum systems. The markets served are primarily in Europe, the U.S. and Asia. Revenues in the Industrial Products Group constituted 53% of total revenues in 2011.
In the Engineered Products Group, the Company designs, manufactures, markets and services a diverse group of products for industrial, commercial and OEM applications, engineered systems and general industry. Products include reciprocating pumps, liquid ring pumps, diaphragm vacuum pumps, water jetting systems and related aftermarket parts. These products are used in oil and natural gas well drilling, servicing and production; medical and laboratory; and in industrial cleaning and maintenance. Liquid ring pumps are used in many different applications such as water removal, distilling, reacting, flare gas recovery, efficiency improvement, lifting and handling, and filtering, principally in the pulp and paper, industrial manufacturing, petrochemical and power industries. This segment also designs, manufactures, markets and services other fluid transfer components and equipment for the chemical, petroleum and food industries. The markets served are primarily in the U.S., Europe, Canada and Asia. Revenues in the Engineered Products Group constituted 47% of total revenues in 2011.
Selling and Administrative Expenses
Selling and administrative expenses increased $25.3 million, or 7%, to $394.8 million in 2011, compared to $369.5 million in 2010. This increase reflects higher variable compensation expense, commissions, corporate relocation expenses, the unfavorable effect of changes in foreign currency exchange rates ($13.2 million) and the acquisition of Robuschi ($1.8 million), partially offset by the benefits of cost reductions, including lower salaries and benefit expenses. As a percentage of revenues, selling and administrative expenses improved to 16.7% in 2011 compared to 19.5% in 2010 due to the leverage from higher revenues and cost reductions, partially offset by the cost increases discussed above.
Other Operating Expense, Net
Other operating expense, net, consists primarily of realized and unrealized foreign currency gains and losses, employee termination benefits, other restructuring costs, certain employee retirement costs and costs associated with acquisition due diligence. Other operating expense, net, of $12.4 million in 2011 included (i) net restructuring charges of $8.6 million, (ii) due diligence costs of $2.1 million primarily associated with the Robuschi acquisition and an abandoned transaction and (iii) net realized and unrealized foreign currency gains of $0.7 million. Other operating expense, net, of $4.5 million in 2010 included (i) net restructuring charges of $2.2 million, (ii) due diligence costs of $2.8 million primarily associated with an abandoned transaction and (iii) net realized and unrealized foreign currency gains of $2.0 million. See Note 19 “Supplemental Information” in the “Notes to Consolidated Financial Statements.”
Operating Income (Loss)
Operating income of $400.7 million in 2011 compares to operating income of $252.4 million in 2010. Operating income as a percentage of revenues was 16.9% in 2011 compared to 13.3% in 2010. These results reflect the specific items discussed above related to gross profit, selling and administrative expense, and other operating expense, net. Operating income in 2011 reflects charges totaling $13.6 million, or 0.6% of revenues, for profit improvement initiatives, acquisition due diligence costs and corporate relocation expenses partly offset by a foreign currency gain associated with the financing of the Robuschi acquisition. Operating income in 2010 reflects charges totaling $7.6 million, or 0.4% of revenues, for profit improvement initiatives, acquisition due diligence costs and corporate relocation expenses.
The Industrial Products Group generated segment operating income of $140.5 million and segment operating margin of 11.2% in 2011 compared to $93.1 million and 8.5%, respectively in 2010 (see Note 20 “Segment Information” in the “Notes to Consolidated Financial Statements” for a reconciliation of segment operating income (loss) to consolidated income (loss) before income taxes). Results in 2011, compared with 2010, were positively impacted by revenue growth and cost reductions, and reflect charges totaling $9.3 million, or 0.7% of segment revenues, for profit improvement initiatives, acquisition due diligence costs and corporate relocation expenses, partly offset by a foreign currency gain associated with the financing of the Robuschi acquisition. Results in 2010 reflect charges totaling $7.6 million, or 0.7% of segment revenues, for profit improvement initiatives, acquisition due diligence costs and corporate relocation expenses.
The Engineered Products Group generated segment operating income of $260.3 million and segment operating margin of 23.3% in 2011, compared to $159.3 million and 20.0%, respectively, in 2010 (see Note 20 “Segment Information” in the “Notes to Consolidated Financial Statements” for a reconciliation of segment operating income (loss) to consolidated income (loss) before income taxes). The improvement in segment operating income and segment operating margin was due primarily to revenue growth, pricing in the energy business, favorable product mix and the benefits of operational improvements and cost reductions, partially offset by corporate relocation expenses.
Interest Expense
Interest expense of $15.4 million in 2011 declined $8.0 million from $23.4 million in 2010. This decrease was attributable to lower average borrowings in 2011 resulting from net principal repayments of $87.6 million, excluding the impact of the incremental $200 million term loan borrowing on November 21, 2011 for the Robuschi acquisition, and a lower weighted average interest rate. The weighted average interest rate, including the amortization of debt issuance costs, decreased to 5.4% in 2011 compared to 7.2% in 2010, due primarily to the greater relative weight of the fixed interest rate on the Company’s 8% Senior Subordinated Notes in 2010, which were subsequently retired in May 2011.
Other Income, Net
Other income, net, consisting primarily of investment income and realized and unrealized gains and losses on investments, was $1.7 million in 2011 compared to $2.9 million in 2010. This change was due to lower year over year net investment gains associated with the assets of the Company’s deferred compensation plan, which were fully offset by a decrease in accrued compensation expense reflected in selling and administrative expenses.
Provision For Income Taxes
The provision for income taxes was $107.4 million and the effective tax rate was 27.8% in 2011, compared to a provision of $56.9 million and an effective tax rate of 24.5% in 2010. The increase in the provision reflects higher taxable income in 2011. The increase in the effective tax rate primarily reflects a higher proportion of taxable income in the U.S. in 2011, the impact of higher tax rates in China, and certain non-deductible expenses, offset by the reversal of certain non-US valuation allowances of $7.3 million and settlements and lapses of applicable statutes of limitations related to uncertain tax positions.
Net Income (Loss) Attributable to Gardner Denver
Net income attributable to Gardner Denver of $277.6 million and diluted earnings per share (“DEPS”) of $5.33 in 2011 compares to net income attributable to Gardner Denver of $173.0 million and diluted earnings per share of $3.28 in 2010. The improvement in net income and DEPS was the net result of the factors affecting operating income (loss), interest expense and the provision for income taxes discussed above. In 2011, charges for profit improvement initiatives, acquisition due diligence costs and corporate relocation expenses resulted in a net reduction in net income and DEPS of $9.4 million and $0.18, respectively. In 2010, charges for profit improvement initiatives, acquisition due diligence costs and corporate relocation expenses resulted in a net reduction in net income and DEPS of $5.8 million and $0.11, respectively.
Year Ended December 31, 2010, Compared with Year Ended December 31, 2009
Revenues
Revenues increased $117.0 million, or 7%, to $1,895.1 million in 2010, compared to $1,778.1 million in 2009. This increase was attributable to higher volume in both segments ($83.0 million, or 4%), net price increases ($32.0 million, or 2%) and the acquisition of ILMVAC in the third quarter of 2010 ($7.9 million, or 1%), partially offset by unfavorable changes in foreign currency exchange rates ($5.9 million). International revenues were 66% of total revenues in 2010 compared to 66% in 2009.
Revenues in the Industrial Products Group increased $76.9 million, or 8%, to $1,099.8 million in 2010, compared to $1,022.9 million in 2009. This increase reflects higher volume (7%) and price increases (1%), partially offset by unfavorable changes in foreign currency exchange rates. The volume increase was attributable to improvement in demand for OEM products and aftermarket parts and services on a global basis.
Revenues in the Engineered Products Group increased $40.0 million, or 5%, to $795.3 million in 2010, compared to $755.3 million in 2009. This increase reflects price increases (3%), higher volume (1%) and the acquisition of ILMVAC ($7.9 million, or 1%), partially offset by unfavorable changes in foreign currency exchange rates. The volume increase was due to improved demand for well servicing and industrial pumps and OEM products, partially offset by lower shipments of loading arms, drilling pumps and engineered packages.
Gross Profit
Gross profit increased $75.8 million, or 14%, to $626.4 million in 2010, compared to $550.6 million in 2009, and as a percentage of revenues improved to 33.1% in 2010, compared to 31.0% in 2009. The increase in gross profit and gross profit as a percentage of sales primarily reflects the volume improvements discussed above, cost reductions, the benefits of operational improvements and favorable product mix.
Selling and Administrative Expenses
Selling and administrative expenses increased $13.3 million, or 4%, to $369.5 million in 2010, compared to $356.2 million in 2009. This increase reflects higher variable compensation expense, corporate relocation expenses and the acquisition of ILMVAC ($2.1 million), partially offset by the benefits of cost reductions, including lower salaries and benefit expenses, and the favorable effect of changes in foreign currency exchange rates ($1.9 million). As a percentage of revenues, selling and administrative expenses improved to 19.5% in 2010 compared to 20.0% in 2009 due to the leverage from higher revenues and cost reductions, partially offset by the cost increases discussed above.
Other Operating Expense, Net
Other operating expense, net, consists primarily of realized and unrealized foreign currency gains and losses, employee termination benefits, other restructuring costs, certain employee retirement costs and costs associated with acquisition due diligence. Other operating expense, net, of $4.5 million in 2010 included (i) net restructuring charges of $2.2 million, (ii) due diligence costs of $2.8 million primarily associated with an abandoned transaction and (iii) net unrealized foreign currency gains of $2.0 million. Other operating expense, net, of $45.7 million in 2009 consisted primarily of restructuring charges of $46.1 million. See Note 19 “Supplemental Information” in the “Notes to Consolidated Financial Statements.”
Impairment Charges
In 2009, the Company recorded impairment charges of $252.5 million and $9.9 million to reduce the carrying value of goodwill and a trade name, respectively, in the Industrial Products Group. See Note 8 “Goodwill and Other Intangible Assets” in the “Notes to Consolidated Financial Statements.”
Operating Income (Loss)
Operating income of $252.4 million in 2010 compares to an operating loss of $113.7 million in 2009. Operating income as a percentage of revenues was 13.3% in 2010 compared to negative 6.4% in 2009. These results reflect the gross profit, selling and administrative expense, other operating expense, net, and impairment charges discussed above. Operating income in 2010 reflects charges totaling $7.6 million, or 0.4% of revenues, for profit improvement initiatives, acquisition due diligence costs and corporate relocation expenses. The operating loss in 2009 reflects the net goodwill and trade name impairment charges totaling $262.4 million and charges totaling $47.3 million primarily associated with profit improvement initiatives.
The Industrial Products Group generated segment operating income of $93.1 million and segment operating margin of 8.5% in 2010 compared to a segment operating loss of $239.4 million and segment operating margin of negative 23.4% in 2009 (see Note 20 “Segment Information” in the “Notes to Consolidated Financial Statements” for a reconciliation of segment operating income (loss) to consolidated income (loss) before income taxes). Results in 2010, compared with 2009, were positively impacted by revenue growth and cost reductions, and reflect charges totaling $7.6 million, or 0.7% of revenues, for profit improvement initiatives, acquisition due diligence costs and corporate relocation expenses. Results in 2009 were negatively impacted by the impairment charges, lower gross profit as a result of the revenue decline and unfavorable product mix, and charges totaling $25.6 million in connection with profit improvement initiatives and other items.
The Engineered Products Group generated segment operating income of $159.3 million and segment operating margin of 20.0% in 2010, compared to $125.7 million and 16.6%, respectively, in 2009 (see Note 20 “Segment Information” in the “Notes to Consolidated Financial Statements” for a reconciliation of segment operating income (loss) to consolidated income (loss) before income taxes). The improvement in segment operating income and segment operating margin was due primarily to revenue growth, favorable product mix and the benefits of operational improvements and cost reductions, partially offset by corporate relocation expenses. Results in 2009 were negatively impacted by charges totaling $21.7 million, or 2.9% or revenues, in connection with profit improvement initiatives and other items.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
The following management’s discussion and analysis of financial condition and results of operations should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, including the financial statements, accompanying notes and management’s discussion and analysis of financial condition and results of operations, and the interim condensed consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q.
On December 15, 2011, the Company acquired Robuschi S.p.A (“Robuschi”), a leading European producer of blowers, pumps and compressor packages. These products are used in a wide variety of end markets including wastewater, mining, and power generation, as well as general industrial applications. Robuschi is a component of the Company’s Industrial Products Group reportable segment.
Reportable Segments
In the Industrial Products Group, the Company designs, manufactures, markets and services the following products and related aftermarket parts for industrial and commercial applications: rotary screw, reciprocating, and sliding vane air compressors; and positive displacement, centrifugal and side channel blowers; primarily serving general industrial and OEM applications. This segment also markets and services complementary ancillary products. Stationary air compressors are used in manufacturing, process applications and materials handling, and to power air tools and equipment. Blowers are used primarily in pneumatic conveying, wastewater aeration, numerous applications in industrial manufacturing and engineered vacuum systems. The markets served are primarily in Europe, the U.S. and Asia.
In the Engineered Products Group, the Company designs, manufactures, markets and services a diverse group of products for industrial, commercial and OEM applications, engineered systems and general industry. Products include reciprocating pumps, liquid ring pumps, diaphragm vacuum pumps, water jetting systems and related aftermarket parts. These products are used in oil and natural gas well drilling, servicing and production; medical and laboratory; and in industrial cleaning and maintenance. Liquid ring pumps are used in many different applications such as water removal, distilling, reacting, flare gas recovery, efficiency improvement, lifting and handling, and filtering, principally in the pulp and paper, industrial manufacturing, petrochemical and power industries. This segment also designs, manufactures, markets and services other fluid transfer components and equipment for the chemical, petroleum and food industries. The markets served are primarily in the U.S., Europe, Canada and Asia.
The Company evaluates the performance of its reportable segments based on, among other measures, operating income, which is defined as income before interest expense, other income, net, and income taxes. Reportable segment operating income and segment operating margin (defined as segment operating income divided by segment revenues) are indicative of short-term operating performance and ongoing profitability. Management closely monitors the operating income and operating margin of each business segment to evaluate past performance and identify actions required to improve profitability. See Note 15 “Segment Results” in the “Notes to Condensed Consolidated Financial Statements” included in this Quarterly Report on Form 10-Q.
Non-GAAP Financial Measures
To supplement the Company’s financial information presented in accordance with GAAP, management, from time to time, uses additional non-GAAP financial measures to clarify and enhance understanding of past performance and prospects for the future. The Company believes the non-GAAP financial measures provide important supplemental information to both management and investors regarding financial and business trends used in assessing its results of operations. The Company believes excluding the specified items from operating income and diluted earnings per share (DEPS) provides a more meaningful comparison to the corresponding reported periods and internal budgets and forecasts, assists investors in performing analysis that is consistent with financial models developed by investors and research analysts, provides management with a more relevant measurement of operating performance and is more useful in assessing management performance. Such measures are provided in addition to and should not be considered to be a substitute for, or superior to, the comparable measure under GAAP.
Results of Operations
Performance during the Quarter Ended June 30, 2012 Compared
with the Quarter Ended June 30, 2011
Revenues
Revenues increased $2.3 million, or 0.4%, to $613.0 million in the three-month period ended June 30, 2012, compared to $610.7 million in the same three-month period in 2011. This increase was attributable to price increases ($12.1 million, or 2.0%) and the acquisition of Robuschi in the fourth quarter of 2011 ($25.1 million, or 4.1%); partially offset by lower volume ($8.4 million, or 1.4%) and unfavorable changes in foreign currency exchange rates ($26.5 million, or 4.3%).
Revenues in the Industrial Products Group increased $1.9 million, or 0.6%, to $329.7 million in the three-month period ended June 30, 2012, compared to $327.8 million in the same three-month period in 2011. This increase reflects price increases ($5.3 million, or 1.6%) and the acquisition of Robuschi in the fourth quarter of 2011 ($25.1 million, or 7.7%); partially offset by lower volume ($10.6 million, or 3.2%) and unfavorable changes in foreign currency exchange rates ($17.9 million, or 5.5%). The volume decrease was primarily attributable to a weak global macroeconomic environment resulting in lower demand for industrial products, principally in Europe (exclusive of Robuschi) and China. The effects of these trends were less evident in Asia Pacific, which experienced growth in markets other than China.
Revenues in the Engineered Products Group increased $0.5 million, or 0.2%, to $283.3 million in the three-month period ended June 30, 2012, compared to $282.8 million in the same three-month period in 2011. This increase reflects price increases ($6.8 million, or 2.4%) and higher volume ($2.2 million, or 0.8%); partially offset by unfavorable changes in foreign currency exchange rates ($8.6 million, or 3.0%). The slight volume increase reflected growth related to well servicing pumps and aftermarket and related services as a result of strong backlog and strong demand for liquid-ring vacuum pumps, which was partially offset by weaker demand for other products in the Engineered Products Group portfolio.
Gross Profit
Gross profit increased $1.6 million, or 0.8%, to $211.9 million in the three-month period ended June 30, 2012, compared to $210.3 million in the same three-month period in 2011, and as a percentage of revenues was 34.6% in 2012, compared to 34.4% in 2011. The slight increase in gross profit primarily reflects the price increases noted above and the effects of the Robuschi acquisition; partially offset by unfavorable changes in foreign currency exchange rates and overall volume declines as discussed above. The slight increase in gross profit as a percentage of revenues was due to the benefits of operational improvements, cost reductions, volume leverage and favorable product mix.
Selling and Administrative Expenses
Selling and administrative expenses decreased $1.9 million, or 1.8%, to $103.1 million in the three-month period ended June 30, 2012, compared to $105.0 million in the same three-month period in 2011. This decrease primarily reflects lower levels of executive and incentive compensation and commissions, as well as favorable changes in foreign currency exchange rates. These items were partially offset by legal defense fees related to the asbestos and silica personal injury lawsuits discussed in Note 14 “Contingencies” in the “Notes to Condensed Consolidated Financial Statements” included in this Quarterly Report on Form 10-Q and selling and administrative expenses for Robuschi, which was acquired in December 2011. Excluding Robuschi-related items, selling and administrative expenses for the three-month period ended June 30, 2012 decreased 7.7% compared to the same three-month period in 2011. As a percentage of revenues, selling and administrative expenses improved to 16.8% in the second quarter of 2012 compared to 17.2% in the second quarter of 2011, primarily as a result of cost reduction efforts.
Other Operating Expense, Net
Other operating expense, net, decreased $5.4 million, to $0.7 million in the three-month period ended June 30, 2012, compared to $6.1 million in the same three-month period in 2011. This decrease primarily relates to a net reversal of restructuring charges of $0.1 million during the three-month period ended June 30, 2012 compared to restructuring charges of $3.0 million during the three-month period ended June 30, 2011. See Note 3 “Restructuring” in the “Notes to Condensed Consolidated Financial Statements” included in this Quarterly Report on Form 10-Q for an explanation of the Company’s restructuring activities. Other operating expense, net, also decreased due to foreign currency gains during the three-month period ended June 30, 2012 of $0.4 million compared to foreign currency losses during the three-month period ended June 30, 2011 of $1.3 million.
Operating Income
Operating income increased $8.8 million, to $108.0 million in the three-month period ended June 30, 2012, compared to $99.2 million in the same three-month period in 2011. Operating income as a percentage of revenues in the second quarter of 2012 was 17.6% compared to 16.2% in the second quarter of 2011. This increase was primarily due to the previously mentioned reductions in selling and administrative expenses and other operating expense, net for the three-month period ended June 30, 2012 compared to the same three-month period of 2011, which were partially offset by unfavorable changes in foreign currency exchange rates. Charges associated with profit improvement initiatives, acquisition-related costs, and other items totaled $1.5 million, or 0.3% of revenues, in the second quarter of 2012 and $5.2 million, or 0.9% of revenues, in the second quarter of 2011.
The Industrial Products Group generated segment operating income and segment operating margin of $40.8 million and 12.4%, respectively, in the three-month period ended June 30, 2012, compared to $34.3 million and 10.5%, respectively, in the same three-month period in 2011 (see Note 15 “Segment Results” in the “Notes to Condensed Consolidated Financial Statements” included in this Quarterly Report on Form 10-Q for a reconciliation of segment operating income to consolidated operating income). The year over year improvement in operating income and operating margin was primarily attributable to the operating results for Robuschi, which was acquired in December 2011 and achieved operating margins of 21.6% for the three-month period ended June 30, 2012, which were partially offset by unfavorable changes in foreign currency exchange rates. Charges associated with profit improvement initiatives, acquisition-related costs, and other items totaled $0.6 million, or 0.2% of segment revenues, in the second quarter of 2012 and $4.1 million, or 1.3% of segment revenues, in the second quarter of 2011.
The Engineered Products Group generated segment operating income and segment operating margin of $67.2 million and 23.7%, respectively, in the three-month period ended June 30, 2012, compared to $64.8 million and 22.9%, respectively, in the same three-month period in 2011 (see Note 15 “Segment Results” in the “Notes to Condensed Consolidated Financial Statements” included in this Quarterly Report on Form 10-Q for a reconciliation of segment operating income to consolidated operating income). The year over year improvement in operating income and operating margin was primarily attributable to incremental profit on revenue growth, favorable product mix and cost reductions, which were partially offset by unfavorable changes in foreign currency exchange rates. Charges associated with profit improvement initiatives and other items totaled $1.0 million, or 0.3% of segment revenues, in the second quarter of 2012 and $1.1 million, or 0.3% of segment revenues, in the second quarter of 2011.
Interest Expense
Interest expense increased $0.1 million, to $4.0 million in the three-month period ended June 30, 2012, compared to $3.9 million in the same three-month period in 2011 primarily due to higher average borrowings in the second quarter of 2012, the effects of which were nearly offset by lower average interest rates and the retirement of the Company’s 8% Senior Subordinated Notes in the second quarter of 2011. The weighted average interest rate, including the amortization of debt issuance costs and capital leases, decreased to 3.4% in the second quarter of 2012 compared to 6.0% in the second quarter of 2011.
Provision for Income Taxes
The provision for income taxes was $28.8 million and the effective tax rate was 27.6% for the three-month period ended June 30, 2012, compared to $27.3 million and 28.7%, respectively, in the same three-month period in 2011. The decrease in the effective tax rate for the three-month period ended June 30, 2012 when compared to the same three-month period of 2011 is primarily due to the favorable impact of provision to return adjustments and a non-U.S. tax law change.
Net Income Attributable to Gardner Denver
Net income attributable to Gardner Denver of $75.3 million and diluted earnings per share (“DEPS”) of $1.51 for the three-month period ended June 30, 2012 compares with net income attributable to Gardner Denver and DEPS of $67.1 million and $1.27, respectively, for the same three-month period in 2011. This increase reflects the net effect of the operating income, interest expense and income tax factors discussed above. Results in the second quarter of 2012 included charges for profit improvement initiatives, acquisition-related costs, and other items totaling $1.1 million after income taxes, or $0.02 on a diluted per share basis. Results in the second quarter of 2011 included net charges for profit improvement initiatives and other items totaling $3.7 million after income taxes, or $0.07 on a diluted per share basis.
Revenues
Revenues increased $74.9 million, or 6.5%, to $1,217.4 million in the six-month period ended June 30, 2012, compared to $1,142.5 million in the same six-month period in 2011. This increase was attributable to higher volume in both reportable segments ($40.0 million, or 3.5%), price increases ($20.3 million, or 1.8%), and the acquisition of Robuschi in the fourth quarter of 2011 ($47.2 million, or 4.1%); partially offset by unfavorable changes in foreign currency exchange rates ($32.6 million, or 2.9%).
Revenues in the Industrial Products Group increased $41.4 million, or 6.7%, to $655.5 million in the six-month period ended June 30, 2012, compared to $614.1 million in the same six-month period in 2011. This increase reflects higher volume ($8.2 million, or 1.3%), price increases ($8.7 million, or 1.4%), and the acquisition of Robuschi in the fourth quarter of 2011 ($47.2 million, or 7.7%); partially offset by unfavorable changes in foreign currency exchange rates ($22.6 million, or 3.7%). The volume increase was primarily attributable to improved demand for OEM products, compressors, custom engineered packages and aftermarket parts and services; particularly in the Americas and Asia Pacific (with the exception of China). Growth in Europe (exclusive of Robuschi) and China was generally flat during the period, where weak macroeconomic conditions were most evident.
Revenues in the Engineered Products Group increased $33.3 million, or 6.3%, to $561.8 million in the six-month period ended June 30, 2012, compared to $528.5 million in the same six-month period in 2011. This increase reflects price increases ($11.6 million, or 2.2%) and higher volume ($31.9 million, or 6.0%); partially offset by unfavorable changes in foreign currency exchange rates ($10.2 million, or 1.9%). The volume increase reflected growth related to well servicing pumps and aftermarket and related services as a result of strong backlog and increased demand for liquid-ring vacuum pumps, which was partially offset by weaker demand for other products in the Engineered Products Group portfolio. See the “Outlook” section in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Quarterly Report on Form 10-Q for information concerning forecasted demand for well servicing pumps in the second half of 2012.
Gross Profit
Gross profit increased $19.7 million, or 5.0%, to $414.4 million in the six-month period ended June 30, 2012, compared to $394.7 million in the same six-month period in 2011, and as a percentage of revenues was 34.0% in 2012, compared to 34.5% in 2011. The increase in gross profit primarily reflects the volume increases, price increases and the effects of the Robuschi acquisition; partially offset by unfavorable changes in foreign currency exchange rates as discussed above. In addition, gross profit for the six-month period ended June 30, 2012 was negatively impacted by amortization of $4.0 million, or 0.3%, related to a fair value adjustment associated with Robuschi inventory during the first quarter of 2012. The decline in gross profit as a percentage of revenues was primarily due to the non-recurring effect of these amortization charges.
Selling and Administrative Expenses
Selling and administrative expenses increased $8.0 million, or 4.0%, to $209.0 million in the six-month period ended June 30, 2012, compared to $201.0 million in the same six-month period in 2011. This increase primarily reflects selling and administrative expenses for Robuschi, which was acquired in December 2011; amortization of an acquisition fair value adjustment related to customer backlog, and legal defense fees related to the asbestos and silica personal injury lawsuits discussed in Note 14 “Contingencies” in the “Notes to Condensed Consolidated Financial Statements” included in this Quarterly Report on Form 10-Q. These items were partially offset by lower levels of executive and incentive compensation and commissions, as well as favorable changes in foreign currency exchange rates. Excluding Robuschi acquisition-related items, selling and administrative expenses for the six-month period ended June 30, 2012 decreased 3.8% compared to the same six-month period in 2011. As a percentage of revenues, selling and administrative expenses improved to 17.2% in the first half of 2012 compared to 17.6% in the first half of 2011, primarily as a result of cost reduction efforts.
Other Operating Expense, Net
Other operating expense, net, increased $9.9 million, to $17.6 million in the six-month period ended June 30, 2012, compared to $7.7 million in the same six-month period in 2011. This increase primarily relates to restructuring charges of $14.3 million during the six-month period ended June 30, 2012 compared to restructuring charges of $4.0 million during the six-month period ended June 30, 2011. See Note 3 “Restructuring” in the “Notes to Condensed Consolidated Financial Statements” included in this Quarterly Report on Form 10-Q for an explanation of the Company’s restructuring activities.
Operating Income
Operating income increased $1.8 million, to $187.8 million in the six-month period ended June 30, 2012, compared to $186.0 million in the same six-month period in 2011. Operating income as a percentage of revenues in the first half of 2012 was 15.4% compared to 16.3% in the first half of 2011. The decrease in operating income as a percentage of revenues was primarily due to the previously mentioned increases in selling and administrative expenses and other operating expense, net and unfavorable changes in foreign currency exchange rates, which were partially offset by improvements in gross profit for the six-month period ended June 30, 2012 compared to the same six-month period of 2011. Charges associated with profit improvement initiatives, purchase accounting, and other items totaled $24.4 million, or 2.0% of revenues, in the first half of 2012 and $6.9 million, or 0.6% of revenues, in the first half of 2011.
The Industrial Products Group generated segment operating income and segment operating margin of $56.4 million and 8.6%, respectively, in the six-month period ended June 30, 2012, compared to $65.1 million and 10.6%, respectively, in the same six-month period in 2011 (see Note 15 “Segment Results” in the “Notes to Condensed Consolidated Financial Statements” included in this Quarterly Report on Form 10-Q for a reconciliation of segment operating income to consolidated operating income). The year over year decline in operating income and operating margin was primarily attributable to restructuring charges of $11.5 million for the six-month period ended June 30, 2012 compared to $3.6 million in the same six-month period in 2011, and unfavorable changes in foreign currency exchange rates. Operating income for the six-month period ended June 30, 2012 also included $1.4 million related to Robuschi, which was composed of $8.8 million of incremental profit and non-recurring amortization charges related to acquisition fair value adjustments associated with inventory and backlog of $7.4 million. Charges associated with profit improvement initiatives, purchase accounting, and other items totaled $21.0 million, or 3.2% of segment revenues, in the first half of 2012 and $5.5 million, or 0.9% of segment revenues, in the first half of 2011.
CONF CALL
Michael M. Larsen - Interim CEO and CFO
Thank you, Rob and good morning everyone. Thank you for joining us. We issued our second quarter financial results last evening and a copy of the release is available on our website at gardnerdenver.com.
I’m joined this morning by Vic Kini, Gardner Denver Vice President, Head of Investor Relations and Financial Planning and Analysis. Before we get into the details of our second quarter results, I’m going to ask Vic to work some information regarding forward-looking statements. Vic?
Vikram Kini - VP, Head of Investor Relations and Financial Planning & Analysis
Thank you, Michael and good morning everyone. As a reminder, any 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 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 related 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 second quarter 2012 earnings press release issued on July 20, 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 now I’d like to turn the meeting over to Michael.
Michael M. Larsen - Interim CEO and CFO
Thanks, Vic. Last night we announced second quarter results that exceeded our expectations in terms of diluted earnings per share. In a more challenging macro environment, the Gardner Denver team delivered margin expansion and a 19% increase in diluted earnings per share exceeding the second quarter guidance communicated on April 18, 2012.
Revenues in the second quarter with $613 million were essentially flat versus the same period last year as the Robuschi acquisition added 4% and currency was a 4% headwind. Operating income for the second quarter was $108 million compared to $99.2 million, an increase of 9% versus the prior-year, reflecting the positive impact of the recent Robuschi acquisition and the impact of operational excellence initiatives.
Operating margin in the quarter was 17.6%, a 140 basis points improvement over the second quarter of 2011. Net income was up 12% to $75.3 million and diluted earnings per share of $1.51 were up 19% of the last year’s second quarter and included unfavorable charges of $0.02 resulting in adjusted EPS of $1.53.
The more challenging macro environment and expected down cycle in Pressure Pumping contributed to a 17% decline in orders to $526 million. The Robuschi acquisition added 4% and currency was a 4% headwind to orders. Cancellations were about $40 million split evenly between the two segments. The book-to-bill ratio in the quarter was 0.86 and our backlog is $654 million as we entered the second half. Cash flow improved sequentially to $66 million, up 36% over the first quarter.
Turning our attention to the individual segments starting with the Engineered Products Group, revenues were $283 million essentially flat as positive revenue growth in our petroleum industrial pump business and our latest cycle project business Nash was offset by declines in Thomas and Emco Wheaton loading arms. EPG operating income increased 4% to $67.2 million and operating margins improved to 23.7%, up 80 basis points from last years second quarter.
On orders, EPG orders in the second quarter declined by 36% to $200 million, driven principally by significantly lower demand in the petroleum and industrial pump business, which was down approximately 60% as well as weakness in Thomas and Emco Wheaton, both down approximately 20%.These declines were partially offset by high single-digit order growth in our later cycle project business Nash, driven by strength in chemicals and oil and gas globally.
Cancellations in our OEM Pressure Pump business were only $4.7 million in the quarter, bringing the total to less than $7 million for the year. After working closely with our key customers over the last months, we now have a grounded view of the backlog for the second half of 2012.
The Pressure Pump team in Tulsa is doing an excellent job dealing with a challenging and very dynamic situation as they continue to execute our aftermarket strategy and pursue orders internationally as well as staying focused on the things that are within our control such as cost, staffing, insourcing and reducing working capital and an effort to mitigate the impact of the downturn. And it certainly helps to have someone with Duane Morgan’s experience and customer relationships on your team when going through a cycle like this one. I’m very pleased that Duane has decided to return to Gardner Denver and I will discuss that in more detail later.
Turning to the Industrial Products Group, IPG had revenues of $330 million, slight increase of 0.6% as the positive contribution from the Robuschi acquisition and strengthened Asia Pacific were offset by weakness globally. Principally in Europe and to some extend China as well as headwind from foreign exchange.
Robuschi added 8% of foreign currency and organic growth reduced sales by 5% and 2% respectively. The IPG team had a very good quarter in terms of margin expansion as operating income increased 19% to $40.8 million and the operating margins were 12.4%, up 190 basis points over last years second quarter making this our second best quarter for IPG margins since 2008.
Robuschi team had a solid second quarter delivering on their revenue and profitability commitments with $25.1 million in revenue and operating margins inline with budget, slightly above 20%. In addition, the team is on pace to free up approximately 30,000 square feet of factory floor space to make room for production from higher cost manufacturing facilities as we embark on our European restructuring efforts, which I will discuss in more detail shortly.
I comment both Brian Cunkelman and the Robuschi team for the commitment to integrating the Robuschi business into the IPG infrastructure while still delivering high quality earnings.
In the second quarter market conditions in the Industrial Products Group became more challenging as the global macroeconomic slow down impacted orders for our products, particularly in Europe and China. Orders in the second quarter were up 1% to $326 million as Robuschi contributed 7% offset by foreign exchange impact of 5% and a 1% organic decline.
By regions, orders in the Americas were about flat relative to a strong second quarter 2011. Europe was down in the mid single-digits and China was down approximately 10%, partially offset by strength in Asia Pacific.
In an effort to mitigate the impact of slowing demand, we’re intensifying our focus on market expansion. As discussed previously, the largest opportunities are the restructuring of our European operations and strategic sourcing. And we remain totally committed to executing at least two important margin expansion initiatives. And we have the resources to get it done.
Let me give you a little more detail on both initiatives. First, the European restructuring plants are nearing completion and the completion of these plants has taken longer than expected due to the complexity of our manufacturing footprint in Europe. In addition, we want to execute the restructuring effectively and manage the risks in a prudent manner that is warranted for an undertaking as large as this.
With that said, we anticipate that we will be in a position to provide you with a more detailed financial framework for European restructuring including project costs, savings, number of sites, staffing, etcetera as well as the associated timing within the first half of the third quarter.
Another critical initiative associated with our 14 x 14 strategy is strategic sourcing from lower cost countries. We’ve strengthened our sourcing team this year and detailed plans have been executed that we expect will deliver the savings that we need to get to 14 x 14. We anticipate that quantifiable results will sharpen our financials in the later part of 2012 and then more so in 2013.
Turning our attention to capital deployment, our balance sheet is strong and our cash flow and financing facilities provide us with ample liquidity to execute on our previously discussed capital deployment strategy. We generated $66 million of cash flow from operating activities in the second quarter and spend $50 million in CapEx to complete previously approved capacity expansions and reduce costs on the shop floor.
On M&A, as previously discussed, in the current acquisition environment though – where evaluation multiples appear rich and given our current trading levels our preference is to opportunistically buyback the stock. And in the second quarter we repurchased 1.7 million shares competing the authorization approved by the Board of Directors in November 2011. This repurchase will impact diluted earnings per shares favorably by approximately $0.09 in the second half of 2012 and approximately $0.18 on an annualized basis.
In terms of capital allocation, our strategy going forward has not changed either. Given our financial strength and strong cash generation, we expect to continue to repurchase our stock opportunistically as well as pursue strategic acquisitions at attractive valuations. We anticipate that we will utilize the current 1.6 million share repurchase authorization from the Board of Directors in the second half of 2012, but have not included that in our guidance.
Turning to our outlook for the balance of 2012, we obviously see the same macroeconomic and foreign exchange trends as everyone else. U.S. manufacturing conditions appeared to be showing signs of softening and globally Europe and China are slowing as reflected in our second quarter order rates. In terms of our outlook and guidance for the second half we do not expect an improvement in our short cycle businesses, particularly in IPG and Thomas in the second half.
Assuming that these businesses essentially maintain 2Q run rate is unfavorable to diluted earnings per share by approximately $0.35 versus our April guidance. We’re not adjusting guidance as a result of the Pressure Pumping. Even though conditions in North America are becoming more challenging, especially in the fourth quarter where we feel we built an appropriate contingency in the April guidance that we gave you.
The headwind from foreign exchange as the U.S. dollar appreciates; it’s approximately $0.05 and will be partially offset by approximately $0.10 of favorability from the already completed stock buyback. As a result, we’re lowering total year expectations and now anticipate that adjusted diluted earnings per share for 2012 will be approximately 530 to 550, down $0.30 from the mid-point of our previous guidance.
We estimate that in a seasonally weak third quarter, adjusted diluted earnings per share will be in the range of $1.15 to $1.25 and the full-year guidance excludes profit improvement and other items totaling $0.40 for the year and $0.03 for the third quarter, resulting in guidance on a GAAP basis of 490 to 510 for the year and $1.12 to a $1.22 for the third quarter of 2012.
At this point, I would like to pass it back over to Vic to give you little more detail on the financials. Vic?
Vikram Kini - VP, Head of Investor Relations and Financial Planning & Analysis
Thanks, Michael. First, we continue to execute well on cost controls in the second quarter as SG&A declined 2% year-over-year to $103 million or 15.8% of revenue, down 40 basis points from the same period in 2011.
In the quarter, foreign exchange impact was unfavorable by approximately $0.07 on a year-over-year basis and $0.03 versus our April guidance. Our guidance for the balance of 2012 assumes current exchange rates, which on a year-over-year basis creates about $0.07 of earnings headwind for the balance of the year, five of which is in the third quarter of 2012.
Our effective tax rate in the second quarter was slightly better than our previous guidance at 28%, and while the rate can fluctuate on a quarterly basis, we expect our tax rate to remain in the 28% range for the balance of 2012. On the balance sheet, operating working capital defined as the net of inventory receivables and payables and accrued liabilities, was 17% of sales in the second quarter, up slightly from the first quarter of this year.
Working capital improvement, especially inventory, remains a top priority and we expect to see solid cash generation going forward. At the end of 2Q 2012 we had approximately $225 million of cash on hand and total debt was $500 million, resulting in debt-to-capital ratio of 28%, giving us plenty of flexibility in terms of capital deployment. Depreciation and amortization was $15 million for the quarter and we expect $65 million for the full-year.
With that, I would like to turn it back over to Michael.
Michael M. Larsen - Interim CEO and CFO
Thanks, Vic. Finally, I would like to comment briefly on the press release issued on Monday July 16th announcing the resignation of our former President and CEO, as well as my appointment as Interim CEO. Specifically I would like to touch on three things. One, affirm Gardner Denver’s commitment to the current strategy and the execution of the associated plans including European restructuring.
Two, affirm our commitment to the Gardner Denver Way and the principles of Leans that has served us so well. Three, talk about what we’re going to stabilize the management team in the short-term and keep our talented employees focused as we move forward.
Let me first say that we’ve broad consensus on the strategic direction of Gardner Denver and the five strategic imperatives that have served the Company so well over the last four years. We remain focused on organic growth, building out the aftermarket, developing innovative products, selective acquisitions and margin expansion. Our strategy is now going to change. On the contrary, we’re going to put even more emphasis on things like building out the aftermarket business and our innovation pipeline.
Our strategy has been and will continue to be supported by the Gardner Denver Way, a business system and culture that is now well ingrained in our operations and our talented employees. It centers on innovation, always looking for a better way of doing things and acting with velocity in all of our processes, whether it’s on the shop floor or in the back office.
Over the years, the Company has trained countless employees on the Gardner Denver Way and Lean principles with a direct focus on driving more efficiency within the business as a means of better serving our customers and ultimately our shareholders. Our commitment to the Gardner Denver Way and Lean is complete. We will not go backwards, instead of taking further actions to develop our Lean expertise, extending Lean into the back office and improving our execution of Lean principles broadly.
Operationally supported by the principles of the Gardner Denver Way, the Gardner Denver team has made great progress over the last four years, as evidenced by our track record on margin expansion, record results in 2011, and a strong start to 2012. With the implementation of Lean across North American and Asia Pacific operations, essentially complete earlier in the year, we shifted our focus to the opportunity in our European IPG operations.
I’ve been intimately involved in developing these plans, and I believe that it’s an absolute necessity to reduce costs in Europe in order to compete successfully. And that hasn’t changed since the announcement on Monday. With Brian Cunkelman’s strong ownership and leadership on the ground in Europe, I’m confident that we will deliver on this important project at the same pace as previously planned and ultimately achieve and exceed our 14% operating margin target in IPG.
The execution of this strategy and the associated plans require great talent and culture. We’ve also made a lot of progress in building a high performance culture. We deployed clear goals and objectives for our teams, we’ve detailed operating rhythms, clear metrics and accountability and we’re always focused on continuous improvement.
With that said, when there is change and cultural transformation of this magnitude, there will be management turnover. Some of it is good, as employees who don’t buy into the new direction of the Company, leave for other opportunities and some of it is unwanted. It is the latter. Unwanted turnover at the senior levels, and middle managed ranks that I as Interim CEO and my leadership team have focused on stabilizing.
And while I’m confident that we have the leaders and teams in place today to execute the plans that are in front of us, we need to stabilize and focus the teams and continue to strengthen our bench by attract and retaining and developing top talent.
Duane Morgan knows how to do that. And bringing him back to lead EPG is going to go a long way in terms of reducing unwanted turnover and energizing the teams to deliver on their commitments in the second half and beyond. In addition, with the return of Duane starting Monday, we just added more than 30 years of energy experience, seven of then with Gardner Denver as well as deep relationships with our largest energy customers, which will serve us well as we navigate the current cycle in our Pressure Pumping business and continue to focus on delivering profitable growth in EPG.
As Interim CEO, my clear goal is to stabilize the team and focus and energize our talented employees globally as we continue to move this Company forward by executing a strategy that has a track record of delivering cash and earnings growth.
Finally, I would like to thank the Board of Directors for their confidence in my abilities and their continued support as they’ve committed to help during this transition. I’m honored to lead a talented Gardner Denver team as Interim CEO and I’m confident in the future.
That concludes our prepared remarks and I would like to open it up for questions. Rob?
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