福斯 (FLS) 2012 Q1 法說會逐字稿

Welcome to the Flowserve Q1 2012 earnings conference call. My name is Kim, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. I will now turn the call over to Mr. Mike Mullin. Mr. Mullin, you may begin.

Thank you, Operator. Good morning, and welcome to Flowserve's first-quarter 2012 earnings conference call. Today's call is being webcast with our earnings presentation, via our website at Flowserve.com. Simply click on the Investor Relations tab to access the webcast and the accompanying presentation. The webcast will be posted at Flowserve.com for replay approximately two hours following the end of this call. The replay will stay on the site for on-demand review over the next several months. Joining us today are Mark Blinn, President and CEO, Tom Pajonas, Chief Operating Officer, and Mike Taff, our Chief Financial Officer. Following our commentary today, we will begin the Q&A session.

Regarding any Forward-looking statements, I refer you to yesterday's earnings release and 10-Q filing in today's presentation slide deck for Flowserve's Safe Harbor statement on this topic. All of this information can be found at Flowserve's website under the Investor Relations section. We encourage you to read these statements carefully with respect to our conference call this morning. Now I would like to turn it over to Mark to begin the formal presentation. Mark?

Thank you, Mike, and good morning, everyone. I am pleased with our solid first-quarter results and proud of the work our employees have done to create shareholder value by taking advantage of our improving end markets, including our long cycle business for the first time in several years. The first quarter played out largely as we anticipated. Back in February, we talked about how the first half of the year would be challenged by a tough 2011 compare, due to the now-stronger dollar and some large low-margin delayed shipments flowing through backlog. We expect those challenging factors to also impact the second quarter, but we see improvement in the future quarters, as our business cycle improves. Our first-quarter bookings represent our strongest quarter since the third quarter of 2008, in spite of the stronger dollar. The bookings strength was broad-based across our end markets, most notably in chemical and oil and gas, while our water markets remain challenged.

Our commitment to after market end user strategies and localization continue to pay off with increased after market bookings of 7% or 9% on a constant currency basis, resulting in an after market annual run rate approaching $2 billion. If you recall, we remained committed to growth investments during the downturn, as well as realigning our business to growth opportunities, and as a result, are now well-positioned to capitalize on what we believe is a key differentiator. We are pleased to see our longer and later cycle project business activity begin to pick up, as demonstrated by the impressive EPD original equipment bookings. I am proud of our employees' commitment and focus as we capitalize on the strengthening cycle. Our strong first-quarter book-to-bill of 1.16 resulted in our highest first-quarter backlog in four years. I will also emphasize that the expected margin going into backlog is improving as a result of firming markets, and Tom's effort to intensify our discipline and enhance our processes. We've also made progress on challenges around working capital and delivering our past-due backlog. Work remains, but I am confident that Tom, Mike and our operations leadership are driving the necessary operational improvements to improve margins, and bring our working capital to more efficient levels.

Looking forward to the balance of 2012, I am encouraged about how the cycle is progressing. We see increased quoting levels and progress on long planned mega infrastructure projects, in spite of lingering macro uncertainty and market softness in Europe. We are optimistic that this increased activity will result in increased booking opportunities towards the end of the year and into 2013. Energy development opportunities in emerging regions continue as anticipated, while the unexpected chemical renaissance in the US driven by shale gas development provides additional support to our optimistic end market views. When we look at the impact shale gas is having on the energy markets globally, we have seen significant increase in the number of projects announced to take advantage of this low-cost feed stock with increased project announcements for combined cycle power plants and chemical processing plants in the US, Europe, Middle East and Asia.

As it relates to power, regulatory clarity in the US may provide the necessary stability to enable significant investments in domestic power to move forward. And while desalination projects have been slow to move forward over the last several years, improving macro and political environments in key regions should support long anticipated investments. While we are optimistic about the present state of our end markets, a meaningful impact on our reported financial results will likely lag, given the long cycle nature of many of these projects. In addition, although these jobs provide attractive long-term after market opportunities, we must still work through some lower margin large projects in our backlog in the second quarter of 2012. But our first quarter bookings and bid levels give us increased confidence in our ability to meet our financial goals this year, and to obtain profitable growth in following years.

Finally, I'd like to update you on the progress I have seen from our new One Flowserve leadership structure. Tom will highlight some of the initiatives, but can I tell you, I am encouraged about what has been accomplished in a short time. I'm already seeing enhancements in leverage across many of our processes, including supply chain, R&D, complex project management, project bidding and contract execution, cost leverage and increased coverage of our customers. While we are early in this current phase in our progression towards One Flowserve, I am confident in Tom and the ability of his leadership team to make the necessary improvements across all of our operations to deliver on commitments to our shareholders, customers and employees. So with that, I'll turn it over to Tom.

Thanks, Mark, and good morning, everyone. Before I review the numbers, I'd like to update you on the progress we've made on our new operating structure we discussed in February. The operating leaders are in place, and we have intensified our efforts towards operational efficiencies, reducing our past-due backlog, on-time delivery, as well as low cost sourcing opportunities, pricing discipline, win rates and other costs including selling, general and administration costs that have an impact on our overall cost position in the business.

Over the last few months, we have driven processes to better serve our customers. R&D is done centrally across the business as we have established common processes. We have leveraged global proposal and contract execution capabilities. We enhanced our focus on customer satisfaction through our on-time delivery commitment focus, and our pursuit of obtaining a high quality product every time, the first time with our customers. And I have added a senior quality person reporting to myself to align our customer base, and provide a central focus here. I'm excited about this progress and the operational efficiency initiatives we have planned.

As Mark discussed, we are pleased with our strong Q1 bookings of $1.25 billion, or an increase of 7.1% versus prior-year, resulting at a strong book-to-bill of 1.16. We saw strength in the chemical, in the oil and gas industries, partially offset by a decrease in water. The after market business remains strong, as we continue to concentrate on this important aspect of our business. While the OE market, in particular the longer-cycle OE market, continues to remain competitive, we were pleased with our overall OE growth rate. In the oil and gas markets, Canadian tar sand activity remained high, with several other tar sand projects continuing to progress with various levels of funding and permitting approvals. Also, quoting activity on Brazilian offshore projects remains strong.

The decline in natural gas prices is driving the end user to focus on oil and liquids in their drilling programs. As reserves of natural gas continue to grow, there is the real possibility of increased US activity as an LNG exporter. Upstream and downstream oil and gas projects remain strong in the Middle East, with gas projects seeing increased activity in Russia and shale gas projects in China. In spite of uncertainty in the nuclear market, several countries continue to move ahead with their nuclear plants, including China, the US and India in particular. The US has most recently received NRC approval for both the Votgle plants in Georgia and the SKANA plants in South Carolina. The increase in natural gas reserves and continued low price of natural gas is driving more combined cycle natural gas plants in the US. This trend may also increase throughout other regions of the world, as more natural gas is tapped.

China and India continue to balance their power needs across a wide range of technologies, including nuclear and fossil applications. The chemical market continued its overall growth pattern with broad-based year-over-year growth. As more natural gas is discovered around the world, it should create opportunities for low-cost gas feed stock for chemical plant applications. The water business decreased, but we see potential activity in China and the Middle East. Mining and pulp and paper, although a smaller contributor to our general industries, continue to grow. Mining should continue to be a good growth sector, based on increased global demand.

Now I would like to turn to our segment results. The engineered product division grew bookings 11.3% in Q1 versus prior year to $671 million, resulting in a healthy book-to-bill ratio for Q1 of 1.25. Book-to-bill for the OE business was 1.59, while the After market business, it was 1.05. The strong OE book-to-bill works to increase our expected highly engineered installed base, and ultimately increases our after market opportunity. The bookings growth is notable, considering Q1 of 2011 included nearly $90 million of bookings related to one major order. After market bookings increased 9% or 11% on a constant currency basis. Our continued focus on the after market, particularly in customers focusing on energy efficiency, operating cost reductions and reliability, continue to build momentum.

Bookings growth in Q1 came from the chemical, oil and gas and general industries, including the mining business, and to a moderate amount, the power business. Sales were up 2.1% on the quarter versus the prior year, or 4.6% on a constant currency basis to $535 million, driven again primarily by sales originating in EMEA and North America. We continue to invest in the emerging markets, with three ongoing capital investments in our new Suzhou green field facility, our green field Brazilian Rio facility and at decision of our third green field block in Coimbatore, India. Also in January, we completed the acquisition of Arcomat, an Argentina-based business specializing in bearings and seal lube oil systems, and electrical control panels used in pumps and seal support systems. Gross margin was 34.3% versus prior year at 35.9%, was negatively impacted as we continued to work through lower margin pass-through backlog and sales mix shifted towards lower-margin OE. Operating income was 17.2% versus prior year at 17.5%, including a gain on sales of replaced assets and appropriate overall expense control. We continue to work on any internal business unit which has performance areas that are not up to Flowserve's high standards. We have a group of quality black belts that are driving key initiatives across these plants in a methodically detailed program. We also have visibility in our backlog of our projects, and review each operational backlog regularly.

I would also like to update you on the performance of Lawrence Pumps, acquired in the fourth quarter of last year. Excluding non-cash purchase price accounting effects, Lawrence got off to a strong start this year. This reflects our ability to leverage our after market capabilities and global sales network to benefit from an acquisition, which fits us well with complementary Flow Control products. The industrial product division grew bookings 3.1% from the previous period Q1 or 4.9% on a currency-neutral basis. The overall book-to-bill ratio was 1.09 in the present quarter. OE book-to-bill was 1.12, while after market book-to-bill was 1.03. The OE after market bookings mix remained essentially the same, while the sales mix shifted 300 basis points towards original equipment in Q1 2012.

Growth came from the chemical, oil and gas, and other businesses, made up by mining, and to a lesser extent, food and beverage. Regionally, the largest growth came from North America, Latin America and the Middle East, offset by a negative growth in Europe and Asia-Pacific. Sales grew 20.9% in Q1 to $213 million, as compared to prior Q1. Sales by destination grew substantially in North America, Latin America, the Middle East and Australia. After market sales were up 11% versus prior-year Q1. Original equipment sales were up 27% versus prior-year Q1. Gross margin was 23.3% for Q1, as we continue to work off lower margin projects in the backlog and the mix shifted to more original equipment sales. Operating margin increased 80 basis points to 8.2%. SG&A expense was essentially unchanged from prior year, which resulted in good SG&A leverage on the increased revenue.

Overall initiatives on driving operating margins and on-time delivery improved steadily. We continue to drive for core operational efficiencies in our business units in order to meet our goal of steadily improving performance in this segment, to deliver on our targeted operating margin of 14% to 15%. We are driving low-cost sourcing opportunities here, along with process changes and some of our IPD plants to drive this performance goal. Flow Control division bookings of $380 million were up 0.7% versus prior year, or 2.6% on a constant currency basis. The overall book-to-bill ratio in Q1 2012 was 1.04, with the after market book-to-bill being 1.04 in Q1 2012. Bookings in the after market business grew 2% versus prior year Q1.

Bookings after market mix of 15% was unchanged from prior year. Bookings increased primarily in chemical, with a more moderate increase versus prior year in power. The pulp and paper business also saw a favorable increase versus last year. Regionally, North America, the Middle East, Latin America and Asia-Pacific overall saw increases in bookings from prior year Q1, offset by decreases in Europe as a result of the macroeconomic uncertainty in several countries. Sales grew 7.8% to $364 million from prior-year Q1. Most of the growth regionally came from North America, Asia-Pacific, most notably China and India and Latin America.

Sale splits between OE and after market remain the same at 85% and 15%. Gross margins grew 80 basis points to 35% on the quarter. SG&A as a function of sales reduced 60 basis points from prior year to 19.9%. Gross margin continued to improve, as pricing actions taken in 2011 materialized, including low-cost sourcing, improved absorption and cost control initiatives. Operating margin increased 120 basis point from prior year to 15.3%. Overall the Flow Control division will continue to focus on high quality growth strategies like automation plus emerging market growth in Russia, India, China, and Latin America. In addition, the Valbart acquisition continued to provide FCD additional penetration in the oil and gas market, with accompanying pull-through opportunities for some of our other products. Additionally, FCD focused on continued execution excellence, as demonstrated by its on time delivery of over 91%, as well as its efforts to drive customer quality initiatives in all of its products and services.

Now, I'd like to turn it over to Mike Taff.

Thank you, Tom, and good morning, everyone. First, taking a look at bookings, the first-quarter bookings of $1.25 billion was our strongest quarter since the third quarter of 2008. Year-over-year bookings increased $82 million, up 7% or 9.4% excluding negative currency impact of approximately $27 million. The increase was driven primarily by EPD original equipment orders in Asia-Pacific, with notable strength in the chemical and oil and gas industries, partially offset by a decrease in the water industry. The strong bookings, notably in our highly-engineered long cycle products and improving end markets supports our confidence in our 2012 forecasted revenue increase of 5% to 7%, as well as our longer-term expectation of 8% to 10% revenue growth through 2016. When we look at sales for Q1 of $1.07 billion, we saw an increase of $78 million from the prior year, up 7.8% or 10.1%, excluding negative currency impact of approximately $23 million. We also had a mix shift on sales, where original equipment revenues increased from 57% to 59%, which had a dilutive impact on margins.

Turning to the financial results slide, gross margins were down 150 basis points, in part due to a mix shift in sales in EPD and IPD towards original equipment. Additionally, as we discussed at the end of 2011, we also continue to feel the impact from a few lower-margin projects booked during the downturn, which are cycling through. Q2 will be similarly challenged, and as we previously guided, we expect to see margin improvement in the second half of the year. SG&A expenses decreased by 170 basis points to 20.6% for the quarter, with strong fixed cost leverage on the higher sales, and the continued tight cost controls. SG&A was also impacted positively by a gain on the sale of an old manufacturing facility in Brazil, as we began the transition to a new more efficient facility later in the year. Operating margins for the first quarter of 2012 were up 20 basis point to 13.3%.

Let's take a few minutes to look at the other expense income line. In Q1 of last year we posted an $0.11 gain from a transaction standpoint below the line, whereas this quarter, we saw a $0.06 loss resulting in a $0.17 swing. As we have discussed previously, this line item is driven by sequential changes in exchange rates, as we mark our foreign currency hedges and balance sheet items to market. The slight strengthening of the Euro was more than offset by the impact of higher volatility in the Yen and Mexican Pesos. Briefly on our tax rate, it came in at 27.5% which is slightly below our stated structural rate of 28% to 30%. We expect the full-year rate to be in the 28% to 30% range, excluding discrete items.

Turning to cash flows, Q1 has typically been a significant user of cash due to seasonality. On a comparative basis, we saw a significant improvement versus the first quarter of 2011, despite increased inventory levels associated with a strong book-to-bill ratio for the quarter. CapEx was $29 million, about $5 million higher than last year, as we continued investing in growth markets, including increased after market capabilities. Also, in accordance with our announced policy to return cash to shareholders, we distributed $17 million in dividends, and repurchased $22 million of stock during the quarter, which is roughly $10 million more than Q1 of last year. We continue to focus on improving our levels of working capital, but work remains. Inventory increased in line with a strong first quarter book-to-bill, and resulting backlog growth anticipated for our 2012 forecasted revenue growth of 5% to 7%. We made progress towards reducing our legacy past-due backlog, which we discussed at year-end and expect to work through most of the remaining balance in the second quarter of 2012, with some residual in the third quarter, which we expect to have a diluted impact on margins but clears the way for margin improvement in the second half of the year and beyond. I am confident that through the improvements we are implementing in our front-end bidding process, as well as our disciplined focus on cash collection we can drive DSO into the mid-60s.

Taking a look at our outlook for the remainder of 2012, following a solid first-quarter start, we are reaffirming our 2012 full-year guidance of $8 to $8.80 per share, including $0.50 of a negative foreign currency impact above and below the line. As we have discussed previously, we continue to expect 2012 earnings to be second-half weighted due to the increased backlog, currency impact and delayed project margin pressures, as we continue to work through the remainder of the low margin legacy backlog in the second quarter. As I mentioned earlier, we continue to expect revenue growth of 5% to 7%, in spite of the currency headwinds we have outlined. I am also confident with the growth in our markets and Tom's operational improvements, we will deliver margin improvement and progress towards our 1.5% to 2.5% operating margin improvement target over the next two to three years. We expect CapEx to be between $125 million to $135 million in 2012, as we position ourselves for growth and continue to execute on our end user strategy. Working capital issues will receive a significant amount of my attention, as we focus on bringing these metrics to more appropriate levels.

And now, let me turn it back over to Mike.

Thanks, Mike. Operator, we are ready to open the line for Q and A.

Thank you. We will now begin the question-and-answer session. (Operator Instructions). And at this time, we have a question from Jamie Sullivan. Please go ahead.

Question. Overall it sounds -- you sound incremental positive on your end market, particularly long cycle and in chemical. Is there anything that you're a bit more cautious on, based on what you see?

Well, as we commented earlier, I mean, we're waiting for the water markets to start to recover as well, and see what occurs there. I think also, we're keeping an overall eye on the power markets. They've been relatively flat. What we talked about in the US is, if we can free up the regulatory environment, also as they start working through the -- each country is going through their nuclear evaluation. Some of them are starting to clear the way. Some of them are still working through it, and then again there's always the wild card of what goes on in EMEA. It still seems to change from day to day. It seemed there was more confidence a couple weeks ago, and now there's concern with what's going on in Spain, and that does impact our business.

Okay, great. And then in the general industries area I know that's a diverse end market for you, the bookings sounded stronger in EPD, maybe a little bit softer than in some of the other segments. Just wondering if you can talk about what's driving the differences there?

Well, I guess in the general industry keep in mind you've got mining, pulp and paper, some of the aspects of that and we saw some improvement overall in the mining business, but also, you have some of our orders that go through distributors that are in that segment. What you do see is distributors start to stock again in their inventory levels, you'll see the benefit of that in the GI side.

Okay. And that's what you're seeing?

We're seeing some of the stocking activity overall. I think it's just generally, as markets start to improve, where we were at this time last year, is we were still talking about being competitive and what we do is we see some of these projects coming more and more online. Our distributors will see the same thing. Generally, industry will see that as well, and that will tend to reflect itself through all aspects of our business.

Great. One last quick one on oil and gas. Outside of the positive long-term fundamentals you're seeing, what maybe over the next year or so what areas do you see the most activity occurring?

Yes, Jamie, this is Tom. One of the good areas and bright spots of the LNG market, and as we mentioned because of the shale gas prices in the US, you could see the LNG become an exporter out of the US. That's a significant bright spot. Also the Canadian tar sands activities has remained high for us, given the overall price of oil, so that is also doing well. And the Brazilian offshore is another growth area for us.

Thank you very much.

Thank you. Our next question comes from Robert Barry. Please go ahead.

Can you quantify how much margin pressure was caused in the quarter in EPD and IPD due to these low margin projects moving through?

Yes, Robert. This is Mike. We've estimated that to be somewhere between 150 to 200 basis points for the quarter, and I think you'll see similar effect in Q2, and then some into Q3 as well.

And that 150 to 200 is both for EPD and IPD?

Yes. The majority of that was EPD, but yes, that's the consolidated number.

And then as we get into the back half of the year, should we expect things to kind of snap back once those new projects move out, or is it going to be more of a gradual improvement?

It's more of a gradual improvement as you kind of come through it. It's the same thing you saw, Robert, going back in time. Our order book peaked, particularly in EPD around the late summer of 2008 and you saw their margins hold well into the late summer of 2010 and you started to see the impact as that business rolled off. It occurs the same way, when you start to build your margins back, but it starts with improved volume levels so you get better absorption overall in the business, and also the pricing as well, but that's how it tends to come back. This is typical of the cycle, and our long late cycle business, this is what you're seeing in EPD, as we kind of wrap up what we saw really in 2010, and some carried over into early 2011, when we talked about the markets being choppy and competitive.

Okay. And then I just wanted to differentiate between the low margin backlog and the past due's, and I believe some of it is inter-related, but I think, Mike, you had alluded to something even flipping into 3Q. And just to be clear, is the low margin -- the few low margin projects, are they kind of moving through as plan and supposed to be out after 2Q and it's the past due's is what you think might linger into 3Q? I just wanted to be clear on that.

Mike and I will take this together. There's a couple of things. There's a couple projects that were not past due that were taken for after market reasons, particularly in the Middle East where it's very competitive, that didn't have a necessarily good margin profile that will come through back-logged over this period of time, that are important to us for the after market side. And then, I think there is definitely a correlation when things become past due, either because of manufacturing, supply chain or the customers don't want it, it does tend to erode margins. So it's a little bit of those, but I think, Mike, you want to carry from there on terms of when it's rolling through?

Yes. I think, Robert, in a way, there's certainly some consistency there and one and the same. Because you can have some legacy backlog and when we refer to legacy backlogs, these were really projects booked during the downturn at much lower gross margins, and they may be on schedule. They may be part of the past due backlog. When we're referring to past due backlog, it's really more of a working capital concern, as well as margin concern. Because as you know, what a project reaches the past due backlog phase, then you start getting into some additional costs such as liquidated damages and things like that.

Okay, great. Just one housekeeping item, is it possible to just break out of the revenue and bookings impact from Lawrence in the quarter?

It was -- we really didn't report that separately, but it was relatively small. I mean, their revenue was in line with what you saw in the business profile, when we announced the acquisition, but I think Tom's comment was, what we did see excluding the impact of purchase accounting, and typically these type of acquisitions, they'll tend to drag on your earnings, literally on your earnings and therefore, of course, on your margins as well until you clear through at acquired backlog. But absent that, aside from that we saw very good leverage in the business. So we're pleased with it. Same thing we saw with Valbart as we worked through it, but what we're focusing on is growing the bookings and the top line of that business. But we saw good margin pull-through, absent purchase accounting.

Okay. Thank you.

Thank you. Our next question comes from Charley Brady. Please go ahead.

Just wanted to focus on EPD for a minute, and there was a pretty wide difference between the mix on OE bookings and OE sales in Q1, and I guess I'm just trying to piece together the impact of what that means for the market later on this year, when you couple that with the fact that you have kind of a natural margin lift from this lower market backlog coming offline and rolling through. Is there headwind, or do you expect the headwind from the OE mix to be that much of a headwind on margins in the second half, and offset the lift on having the margin backlog move out or not? What do you think the mix looks like, OE market as we go through this year?

I think I understand your question. Let's set aside what we call the legacy backlog, and just talk about the business from here going forward, and you saw this in the past, '06 and '07, a couple of things occur. When you do see these book-to-bill levels in EPD, of course what that means is over a period of time, you'll see a mix to more original equipment business, but keep in mind our after market business is a lot bigger in EPD than it was back then. So all other things being equal, sure, mix does tend to put a pressure on your margins, but I think another thing, if you look over the last couple years at their sales levels in EPD, they've been running on average in bookings and sales, $225 million or less in sales on the OE side. So as that starts to grow, you're going to get better absorption and fixed cost leverage in the SG&A line. So how it works out, mix shift does tend to impact margins, but growth in the OE is good from a number of aspects. One, you get better absorption in your plants, fixed cost leverage on the SG&A line, and then also, that's an indicator that your markets are starting to get traction, and you can drive better pricing through overall in the business. So those are going to be your margin impacts going forward.

Okay. And just so I'm clear, it sounds like from what you're saying, then that, we should expect -- because the mix shift has gone, that doesn't necessarily mean we get a significant downtick in margins in the second half, because of the fact it's less?

Well, overall the margins at least in the first half and some in the Q3 will be more around the legacy backlog, and then as you go forward, as this kind of works out what will go on in our after market business as well. You'll see some impact from more OE going through mix alone, but also a benefit from absorption and SG&A as well.

Charley, it's Mike. The other thing to keep in mind on EPD obviously is on those OE orders. They have a run rate of 12 months plus. So something we're booking today really starts flowing through revenues in three, four quarters down the road.

All right, okay. And then my next question would be on the SG&A line across the segments, that's obviously come down on a year-over-year basis nicely. Can you give us a sense of kind of what your SG&A targets are for the business segments? Where are you thinking of that, too?

I think overall, we're still trying, as a business drive it to 20% or below. If you look at EPD, a lot of that as a percentage overall is going to be what we just talked about. As we start to grow the OE business, we're going to get better fixed cost leverage. You're seeing the same thing in IPD. They had good cost control year-over-year and they're starting to grow their top line and FCD has always done a good job of managing that. And corporate has been relatively stable now for a couple of years. So what we're looking is to continue to leverage SG&A as we grow our business. And do keep in mind, this SG&A run rate does reflect investment in QRCs that we'll still realize the benefit from, hiring of engineers, putting a lot of programs in place to drive growth overall in our business. So we'll get the leverage not only from costs management, but to start to realize some additional returns from the SG&A we've invested in our business.

Charley, I would also add if you look at what we've done structurally since the beginning of the year, we've centralized the research and technology function. So that should give some good positions going forward. We've also centralized global projects, both on the proposal stage and the contract stage. That should help along with the quality overall initiative for the Company. So those process changes will also add to the position that Mark mentioned.

Yes. Charley, Mike. Also just to note, related to SG&A, we mentioned our overall goal over the two to three year period is to get that percentage to 18%. So we're driving towards that on a consolidated basis.

Great. Thanks.

Thank you. Our next question comes from Brian Konigsberg. Please go ahead.

Just coming back to North America, obviously it seems like there has been quite a change in the activity going on in the market. I'm just curious, as we look forward, do you anticipate you're going to require more investment to serve the opportunities that you're seeing, and separately, as far as timing goes, when do you start to see kind of a pickup in activity related to these projects that we're hearing about in chemical and oil sands and others?

As they start to let these out, if you look at our business over many, many years, we have a well-established presence in the United States and in EMEA. We've done a lot to drive efficiency in that over the last couple years, as we've repositioned our business to emerging markets, but we have ample resources in North America that support the growth. Not only from domestic capabilities, but also a lot of our strategies to do some low-cost manufacturing in our facilities around the world. So as you look at these projects as they come online, be it on the nuclear side, some of the chemical plants with the natural gas feed stock and the impact in natural gas itself, you're seeing movement from gas to liquids and the impact that's going to have, pipelines, all of those things still represent opportunity out there. I think on the power side, as I mentioned in my comments, we're going to need to see some clarity around regulations, but as that starts to free up, but there is demand for all of the things that I talked about. So they'll need the infrastructure for it, but from our investment side it doesn't require significant investment to support our current and our future markets in North America.

Just as far as timing, when do you anticipate that opportunity starts materializing to a more significant run rate of revenue, orders and revenue?

I mean it's going to -- it's obviously going to vary depending on the industry. I think the good thing is we see good growth across many of the infrastructure areas. So if you take nuclear, I mean nuclear, I would say is imminently here because of the SKANA project that they just announced and the Votgle previous project in Georgia, so that one is going along good. You're going to see opening up on a combined cycle power plants because of low price of gas. Because of the EPA requirements, a lot of fossil units are going to require some revamp and environmental equipment on the back end in order to comply with the EPA requirements. You've seen several customers announce several chemical plants on the ethylene side of the business, in various parts of the US. So I think that's probably got a little bit longer runway, and then probably the last thing which has some good growth prospects going forward, but of a little bit longer term would be the LNG as an exporter, as a result of the low price of natural gas.

And if I may, just one last question, on guidance you kept the range, which is still fairly large, $8 to $8.80. Curious, why is it still so wide? It sounds like you do have more confidence in what you're seeing in the market. Maybe you could discuss what are kind of the big swing factors here.

Well, a couple things. Normally if you followed our cadence, we maintain our guidance typically into the fall. You also have big volatility in currency. Look at impact it had year-over-year just in the first quarter alone of $0.17 overall. So that's part of the reason that we do it and it may be $0.80, but it's a 10% range. It's not uncommon that companies have a 10% range overall in their earnings guidance, but as we drill down towards the end of the year and get more information, we always try to put it out there in the street.

Thank you very much.

Thank you. Our next question comes from Kevin Maczka. Please go ahead.

On pricing there's a comment about actions you took in 2011 on FCD. I'm just wondering if you can talk about pricing in general on the OE side, and is it fair to say that if the past-due backlog and the bad margin backlog is pressuring margins by a couple hundred basis points now, that current orders are coming in and closing that gap?

Yes. The comment that was in the script was on the FCD side of the business, and what it related to was a number of different initiatives that go into pricing, one of them being our lean initiative there, our initiatives in terms of low cost sourcing which we feel pretty good about on the FCD side, because it's a pretty high percentage of business, between 30% to 40%. We've had a number of other initiatives going on in terms of just material costing. We've continued to maneuver things around our worldwide asset base to capture the overall margin. So those initiatives that we took at a very detailed level are now beginning to bear fruit as we execute those orders.

So I mean part of that comment was for Tom to help you understand how he's running this business, and we think that's important for folks to understand. If you go back to where we were a year ago, a year ago plus when we talked about the shop being competitive, you were looking as we mentioned then about absorption in your factories, filling your factories. Sometimes you had to take projects that had no margin in them to make sure you could absorb your factories. As we started talking about our markets firming up, as we did towards the latter part of last year, what that said is some of the capacity in the industry was starting to get picked up. And now as we roll into this year, we talked about firming yet still competitive markets, but a lot of what Tom is doing relative to some of the initiatives on the front-end to drive pricing. I think to take it even further, Mike's comments earlier is, you'll see the benefit of a lot of these initiatives over the next three to four quarters.

Got it. And then shifting gears to the working capital, with the inventory increase that we saw. And I understand that bookings were up and revenues were up, but at some point here, should investors be expecting that we start to see some of that actually liquidate and not grow less than revenues are growing, but actually declines in the inventory levels?

Yes. Kevin, good point and no, you're absolutely right. I think traditionally, more seasonal growth in inventory year-over-year. You saw the similar thing last year where we had inventory effect for about the use of about $107 million this year, and I'm thinking on the statement of cash flows it's about $112 million, $113 million. So no, that is one of the top priorities that I have, and Tom and I are actually working together to improve on-time delivery to get this backlog off, to increase our inventory turns. Some of the things we talk about everyday here and I'll continue to talk about those, so big focus on working capital. I still believe there's several hundred million dollars that we can monetize out of our working capital balance between accounts receivables and inventory and accounts payable. Just better management of that, and that's our long term goal. We'll get it done.

Okay. Thank you.

Thank you. Our next question comes from Scott Graham. Please go ahead.

Just really one question and this one is for Tom Pajonas, just wondering, what are some of the things that you're working on right now? I know Mark rattled through a couple of things that you were doing that were starting to have an effect and maybe what are the two or three big buckets that you're focused on improving the operations and when will we see their benefit in the margin?

Yes. That's a good question. If you look at since I took over, the first thing I would just say structurally, it may not seem like a lot, but we have the people in place, we got the structure in place, people know what their goals are. They know what their runway here is in terms of hitting those particular goals. I would say very good clarity on getting the business set up. In terms of the specific initiatives, I mean obviously, the customer focus one is the one that is extremely powerful in the organization here, especially the on-time delivery and cost per quality. Those are two areas that we will drive religiously here in all the different units, and I think you're going to see some good effects as a result of the initiatives in those areas.

Mike already mentioned the working capital, so I won't go through that, but other areas like centralizing, casting buys for the whole business across the business, so that we get very good at specification development, expediting vendors, making sure that when we put something in the vendor shop, we have the capacity. So we're looking at centralizing several of those items including the motors. And then I would say two or three other areas, research and technology, dropped that on to one head, so I would expect to see much more robust process than which we had in the past there. And then proposal and contract management, where we can now begin to centralize on terms and conditions differently. We can begin to centralize on how we cost a job, and so on will I think, reach some benefit going forward.

That's very helpful, Tom, thank you, just the only other question is with respect to the implementation of these initiatives, have you found the need to move people from flow control where you ran that business for so long and so well into the other operating unit to kind of get the point across?

Yes. That's an excellent point. We constantly look at moving people around, but I would say, for instance, one individual that we did move around toward the back end of 2011 was the Vice President of Supply Chain moving from the Valve Group into the Pump Area, and that was I think we mentioned at that time to kind of get at some of the low cost sourcing initiatives that we have, plus he's a good commodity strategist relative to the mouldings and the castings here that we have. So that was certainly one area that we have. And then we have we have moved people I would say at a much lower level in the organization on the project side of the business, but we'll continue to drive that across those platforms, now that we have an easier mechanism to do that from a structural standpoint.

That's helpful, Tom. Thanks you. That's all I had.

Thank you. Our next question comes from Mike Halloran. Please go ahead.

So could you talk about utilization levels, both for your facilities, as well as what you're seeing in the industry? And with a little bit better order trends that you're seeing this quarter, maybe also a commentary on how you expect that utilization level to track through the year?

I think really the focus in what you're seeing is on the highly-engineered rotating equipment side around capacity utilization, and there's a couple of things that happened with capacity, if you saw last year, some of the capacity has changed hands into companies that have a lot of, certainly a tremendous amount of discipline. A good example is the ClydeUnion assets going into SPX. SPX well-run good discipline. So the assets have become more disciplined and then utilization is starting to go up overall generally in the industry. You saw a lot of capacity come online in 2010 and in 2011, but that's starting to get claimed with projects that came through primarily in the Middle East in '10 and '11, but also with some of the things that we're seeing. So as we look over the horizon, in the engineered rotating equipment side you're seeing the industry do it as well and start to think about how they want to use capacity over the next 18 months. So it's starting to pick up.

That's encouraging, and then when you think about the margin improvement potential. On a qualitative basis could you just talk about where you see the biggest opportunity in buckets in terms of pricing, leverage or kind of internal operational oriented improvement?

I mean market-driven, there's going to be certainly the pricing opportunity as things firm up on the EPD on the engineered side, and leverage is going to be around the fixed cost leverage absorption and SG&A side. So I would say there are balance around all three of those, if you think about it, and that is we spent a couple years realigning our business, driving a lot of the front end in investment to emerging parts of the world. And now what Tom is focused on is we've got a lot of talent and capabilities in this business, is bringing that efficiency and driving execution across the business to leverage margins overall in our business. So we look at all three of those really as being able to leverage our margins going forward, and that's what we talked about, 150 to 250 basis points. It comes really from all three, because if you looked historically back in the 2007-2008 time period, those were pretty much very high-priced environments where people were paying for manufacturing slots. We don't need that environment again to get to the 150 to 250 that we're talking about. Really, it's just driving the three things you talked about.

Great. I appreciate the time.

Thank you. Our next question comes from William Bremer. Please go ahead.

Last quarter you gave us some idea in terms of how much you monetized of the lower margin pass-through backlog. I believe it was approximately $60 million, and you sort of indicated that you would like to bring down the total below $200 million. Would you sort of quantify what we did this quarter, and are we on track?

Yes. Good question. We are on track. We made some improvement in our pass-through backlog, and I'd say we're probably about halfway where we needed to get through from that quantification of that $60 million or so. So we improved it I think somewhere in that $10 million to $20 million range or so. Not quite half, but we made improvement, and we certainly feel confident we'll get there by second quarter, into the third quarter.

Okay. So that's the reason why we're sort of approaching the third quarter here a little bit. And then my other question is on the EPD segment, the sale of the facility. To back that out, I want to confirm my numbers here, but my adjusted operating margin comes into the range of about 15 plus there, just wanted to confirm that with you.

Yes, that's about right.

Okay. Are there any other facilities that we should be thinking about longer term that didn't achieve the objective of management in terms of completely selling them off and then ramping up a more efficient line?

Well, I mean we talked about we've had a facility in Brazil for quite a number of years, but it was very constrained. One, because of where it was located. It was constrained in terms of manufacturing, transportation, test, size, capabilities and so to respond to the market there in Brazil we decided to build a new facility, but this sale opportunity, if you think about it, we got a very good price for our old facility. It almost covered half the cost of our new facility, which is much larger, has more product offerings, and more capabilities. So we're always going to do what makes sense in terms of overall in our business, and we were able to sell this facility, monetize it, pay for almost half of the new one, and start the migration process to our new facility. So in terms of being able to drive good efficiency in our business and make the right long term decisions for the Company and our shareholders, you can expect management will do that.

Mark, thanks for the color.

Thank you. Our next question comes from David Rose. Please go ahead.

Good morning. A couple quick ones. You mentioned a couple of items that were driving improvements on the front end of the business, particularly the backlog. As we look at the backlog and try to get a little more comfortable with the backlog going into a higher margin level in the back half of the year, what sort of KPI should we be thinking about, and maybe give us some examples of how that backlog improves? Because I get the pricing standpoint. You mentioned FCD, for example, and on time delivery. I think you gave us a 91% number. Are there particular KPIs that we should be looking at for both EPD as well as IPD?

I think when we discuss operational metrics, there is a correlation between on-time delivery and margins in almost all instances. So I think as you follow around on-time delivery, but I think as you look at some of the things we discuss, a leading indicator of margins is certainly going to be -- a long leading indicator is going to be our commentary around the markets, especially on the large projects, and firming markets, which tend to give you some power in terms of absorbing your facilities and getting the fixed cost leverage. I think also the pricing that we talk about, it's still competitive out there, but as markets start to firm, pricing comes around. So that's probably one of the longest lead indicators in terms of margin.

One of the shortest ones in terms of bookings in the sales line is going to be our after market business. As that grows, that's high-margin business and very stable margin. So if you look at our order book, those are probably your indicators from longest to shortest from the -- going back to Mike Halloran's comments earlier from the SG&A side, it's just margins around how we're going to leverage SG&A, cost controls, how we're going to leverage our SG&A overall in the business, and then I think finally, the operating metrics. Because we can drive efficiency in our business and efficiency correlates to margins. So I'm just trying to lay it out for you in terms of our commentary in this Press Release and following the business over the last couple years, that's how you can follow the margin profile of our business.

That's helpful. I was just trying to understand how do we get more comfortable that backlog won't have some of the same headwinds that the first half did and, that was really getting the backlog out the door, on time delivery.

Yes. I think it is. That's one of the most important things is to clear this, as you see at the end of the cycle, and as we start clearing the backlog and driving some of the initiatives that we have, some of the comments you've heard us talk about on our long lead time projects now, we will start to see over the next three to four quarters. But I think the ones that will have the more immediate impact that you can watch are going to be our after market growth in our business, our SG&A leverage, and then our periodic commentary about operational leverage that we're getting in the business. If you take a step back, I know we just talked about EPD's margins. Well, in the highly engineered pump business, those are the strongest margins that are out there, and so we continue to drive those higher and higher, but we'll refer to operational metrics and things that we're talking about. Those tend to have an immediate impact as well.

Okay. Then lastly, Mark, on that note on after market bookings figures, when we look at the figures, how are you thinking about the comparisons in Q2 2012 versus Q2 2011? If I'm not mistaken, EPD and IPD have easier comparisons than Q1. Do we still think about it in terms of year-over-year comparisons?

Let me make sure I understand your question. In terms of after market, is your question of Q2 of 2012 versus Q2 of 2011? Is that your question?

Yes. Q1 of 2011 you had a fairly significant increase. Your comparisons looked tougher. So do you think about it that way? Do they get easier in Q2 versus last year?

We typically look at it -- this is a comment back from years ago, and not being quarter-to-quarter and a good example is this year you look at FCD's bookings and relatively flat slightly up on constant currency, but if you look at last year, it was up 30% over the prior year. So we really look at long remember it trends overall in our business. We'll look at rolling four quarter because there is seasonality to our business. I can tell you if you look at order books and sales in third quarter, particularly in EMEA, a lot of folks are on vacation. So we tend to look things over a rolling period of time. What we like about the after market business is it's approaching $2 billion. It's been high margin stable business and we've been growing it at the 7% to 8% clip, and if you look at the global installed base around the world net, it does not increase by 7% to 8%. It's actually less than that. So what we're doing is we're not only taking care of the incremental installed base, but gaining share through our end user strategies. That's how we look at it.

Okay, great. Thank you.

Thank you. Our next question comes from [Stuart Sharp]. Please go ahead.

I was wondering if there was any impact you're seeing where you expect to see from some of the consolidation in the oil and gas business, Sunoco and other recent Energy Transfer Partners acquisitions in private equity and whether you see that having any impact on pipeline operation and refinery and so forth?

Yes. I mean it's early to tell with EPT and Sunoco what's going to happen, but if you take a step back and you look at what's happened in the oil and gas industry and particularly in our industry, some of the efforts over the last couple of years, it really supports the thesis that energy, oil and gas, power and even water, has a strong secular growth cycle, and that's why these folks are making these investments. That's why industries are consolidating to get leverage to be able to get access to the capital for the investment that's required. So it does support our long term trend assumptions in our business over the next 10 to 20 years about the growth opportunities in the energy side of the business.

Okay. Thank you.

Thank you. Our next question comes from John Moore. Please go ahead.

Just one question on the orders, and this is probably a follow-up to the one asked previously. The order growth in EPD was obviously very impressive this quarter, and bodes well for that division here later this year and into 2013. And I realize the IPD and FCD divisions face some more difficult comps, but would you say the strength in EPD you saw this quarter is actually an indication that IPD and FCD orders should accelerate from here, or are they facing some other kind of end market trend that EPD isn't?

No, no. We talk about the short cycle business and I'll just caution not to make a call in a quarter. There could be a compare issue to last year, one project. You certainly saw that in EPD. You take a step back and think about Tom's comments. We had a very large project that came through. It was very competitive, but will offer great after market opportunity for 15 to 20 years, and that was in our order book last year in EPD. So what it does tell you, if you see sustained growth in the long cycle business, that's indicative, and it's later cycle, it indicates that long cycle business is starting to come back. What that means for our industry is that capacity starts to get utilized, to the question earlier, that also you're starting to get better absorption and pricing through.

What it will do is that will tend to run on for a period of time. I mean if you think about it, EPD's long cycle business stayed in our P&L till really the latter part of 2010. So that's what it means overall for our industry. It also means -- but it brings along investment in the short cycle business and brings along after market opportunity. So that's the way to think of it, and if you think about our commentary, we've seen firming markets and we've seen opportunities for some of these projects that you've seen engineering and contracting firms talk about, to come our way towards the end of this year beginning of next year. So this is typically how it feels when things start to pick up overall in our industry. On the short cycle business, I would always say, you need to look over a couple quarters and look at growth rates because that can fluctuate certainly from quarter-to-quarter, but we like what we've seen in our short cycle business and we're looking to do well.

Okay, perfect, thank you.

Thank you. Our final question comes from Jeff Beach. Please go ahead.

At the beginning of the presentation, you highlighted shale gas, tar sands, LNG opportunities. My question is, are all of these large enough in size to actually grow that slice of the pie in view of your growth opportunities in Asia, the middle east after market, so many other drivers? Can you actually increase that percentage going into let's say North America energy?

I mean we can on a relative basis, but one thing I always comment, Jeff, is not any one of these things is going to become a predominant part of our revenues. We're diversified across multiple applications, but I think the theme is consistent. You're seeing these more complex applications come to market, and that's where our technology and engineering capabilities are able to respond. What we didn't talk about was our increased presence in the thermal solar. We've seen increased orders in some of our molten salt pumps. That came from basically very little to nothing a couple years ago.

So these are all applications that we're able to take our capabilities and our global manufacturing and address these markets. Clearly one notable thing you've seen in the United States, and I do think if you lack at our North America growth, it will have a notable impact, is with gas being at this cost, it's becoming a low-cost feed stock and is bringing investment on in the chemical industry, which we saw the chemical industry, basically I think it was about four years ago as it started to really cycle down hard, and when you saw it come back which it typically does it with GDP, but this is kind of an added boost in North America, being that natural gas is a low-cost feed stock.

And then specifically within this Midstream infrastructure in North America energy, is there one division that benefits more than the others, and what would be a couple of the major products?

Well, I think they all three benefit on Midstream application and this is even a further enhancement from the One Flowserve. Clearly, the type of rotating equipment that goes on to some of these pipeline structures, particularly the liquid ones, are supported by EPD and IPD, but you have, for safety reasons, you have valves that are at certain locations that are either modulating the flow or for example in our trending mounted ball valve that are actually safety valves that it can isolate a piece of the pipeline to make sure, if there's any problem, it doesn't spill over into other parts of the pipeline. So we do a lot of our products are able to go into these pipelines, particularly on the liquid side. And now with what Tom was talking about now we can even bring more of an opportunity to bear when we go to pursue these opportunities.

I would also add one other thing to that. A lot of these pipelines are adding capacity. So we have a lot of after market growth opportunities on the pipeline area, also.

All right. Thank you.

Thank you. This concludes our question-and-answer session. I'll now turn it back to Mr. Mullin for closing remarks.

Thank you, Kim, and thank you all for joining today.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.