福斯 (FLS) 2013 Q2 法說會逐字稿

Welcome to the Flowserve second quarter 2013 earnings conference call. My name is Vanessa 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 Jay Roueche. Mr. Roueche, you may begin.

Good morning, everyone. We appreciate you participating in today's call to discuss the financial results of Flowserve Corporation for the second quarter of 2013, which we announced yesterday through our press release and form 10-Q filing. Joining me on the call this morning are Mark Blinn, Flowserve's President and Chief Executive Officer, Tom Pajonas, Chief Operating Officer, Mike Taff, Chief Financial Officer, and Mike Mullin, our Director of Investor Relations. Following our prepared comments, we will open the call to your questions, and instructions will be given at that time. Before turning the call over to Mark, I would like to remind you that this event is being webcast and an earnings slide presentation is available, both of which are accessible through our website at www.Flowserve.com in the investor relations section. An audio replay will also be available on our website approximately two hours following the conclusion of the live call. Both the audio replay and the slide presentation will remain on our website for a period of time over the next few weeks.

Finally, please note that today's call and the associated earnings materials contain forward-looking statements that are based upon forecasts, expectations, and other information available to Management as of July 25, 2013. These statements involve numerous risks and uncertainties, including many that are beyond the Company's control. As such, we encourage you to fully review our Safe Harbor disclosures contained in yesterday's press release and slide presentation, as well as our filings with the Securities and Exchange Commission for more information. These documents are accessible on Flowserve's website under the investor relations section. Please note, except to the extent required by applicable law, Flowserve undertakes no obligation and disclaims any duty to update any of today's forward-looking statements. I would now like to turn the call over to Mark Blinn, Flowserve's President and Chief Executive Officer, for his prepared comments.

Thank you, Jay, and good morning everyone. I am pleased with the operating and financial results for the second quarter, as our dedicated employees continue to deliver on targeted improvements across our operations. Each segment contributed to solid earnings growth, demonstrating the leverage of our diverse and stable business profile and the propensity for ongoing operational improvements is significant. Our continued focus on delivering on our customer commitments, operational excellence, thoughtful cost control, and capital structure efficiency are returning value to our shareholders, drove EPS growth of 27% year-over-year. We believe this formula of improving operations and reduced share count will produce our solid earnings growth for 2013 and provide leverage over the coming years as we prepare for more meaningful expected growth.

As we progress through 2013, we are capturing internal opportunities by improving the operations, positioning the Company to more efficiently integrate and leverage future inorganic bolt-on acquisitions, optimizing our capital structure efficiency through returns to shareholders, and preparing the business to maximize earnings potential of large project work, which is expected to reach award stage later this year. While the summer appears to be more stable than the last several years, economies around the world are recovering at different rates. Europe seems to have stabilized, albeit low levels. We believe North America has good opportunity ahead on the strength of gas and chemical projects. While macro growth in Asia-Pacific is mixed, our objective is to further increase Flowserve's presence in the region. Latin America should see increased customer spending over the next few years, and Russia and the Middle East will require increased investment to expand and update capacity.

As we have previously mentioned, large order has shifted to the right and none were booked again this quarter. This is nothing new, but we remain optimistic in our core energy markets and the significant build-out expected in North America and the emerging regions. Given the current market environment, we are pleased with second-quarter bookings of over $1.2 billion. This amount represents a 1.3% increase year-over-year, and a 3.3% increase sequentially, reflecting the continued strength of our run rate original equipment and after-market business. Over the last few years, we have grown this type of work into a strong recurring franchise. In the after-market business alone, execution of our global end-user strategies drove solid bookings this quarter of over $500 million, which is encouraging considering the seasonality of our business and some ongoing deferrals of scheduled maintenance in certain regions due to strong refining margins.

Looking at margins, our focus over the last year on driving improvements within the four walls of Flowserve drove a solid increase in gross margins. In particular, IPD and FCD realized significant improvement in gross and operating margins. Additionally, EPD gross margins were able to overcome an unfavorable mix shift, through higher sales and operational initiatives, to show an increase as well. Our One Flowserve initiatives, and other investments in operational excellence, including quality, project management, and other company-wide programs focusing on the customer, are positioning the business to drive profitable growth. In addition, solidifying an expense management culture remains a top priority, which will effectively support our operations as we generate strong leverage on these costs. Looking briefly at segment performance, EPD's continued focus on operational excellence and improvements, and disciplined project pursuit, has grown the top line and is steadily improving the quality of the backlog in this traditionally late-cycle business.

IPD's operational improvements delivered impressive margins of 12.8%, demonstrating substantial progress towards achieving this segment's target range for operating margins of 14% to 15% by 2015. FCD's strong and consistent operating performance was driven by operational excellence and increased leverage on investments to support the oil and gas markets. Looking forward to the second half of 2013, we expect to build on the momentum of the first half. And with another quarter of solid operating improvements behind us, I remain confident we are focusing on the right areas and taking the right strategic actions needed to deliver on our commitments to our customers, while profitably growing the business and delivering value to our shareholders. Let me now turn the call over to Tom for his operational review.

Thanks Mark, and good morning everyone. As Mark discussed, we continue to focus on the customer and internally on our operations and costs, as we build on the momentum gained last year. I'm proud of the substantial progress we have made towards our operation improvement targets and the return earned on our investments to strengthen our leadership and optimize our operating platforms. Impressive margin improvement, particularly in FCD and IPD, validates our customer focus strategy, as well is our efforts to improve our on-time delivery, reduced cost of quality, and our ongoing investment in and development of our employees. Our One Flowserve initiatives are also generating solid returns, as we leverage global competencies across our operating platforms in areas such as project management, low-cost sourcing, and research and development.

We continue to be excited about the propensity to improve our core business fundamentals, which include leveraging our global sales force as we focus on the customer and overall growth. The success of these efforts is evidenced in part by our strong margin improvement. On a consolidated basis, gross margin increased 150 basis points year-over-year. At the segment level, FCD delivered impressive leverage by continuing to operate at a high level by focusing on quality, cost reduction, and low-cost sourcing. In addition, FCD also benefited this quarter from the mix shift towards after-market sales. IPD's margins expanded again this quarter as well, with operational excellence initiatives beginning to take hold as we progress towards our targeted operating margin target of 14% to 15% by 2015.

Looking at our new work, bookings this quarter were up nearly 2% year-over-year on a constant currency basis, driven by run rate and original equipment orders in after-market. This result demonstrates the value of our diverse exposures, as strong bookings in FCD more than offset decreased IPD bookings and relatively flat EPD bookings. While our core reoccurring after-market and run rate activity essentially comprised all of our bookings, we do remain confident that a number of large projects are in the pipeline, and that they will begin to be released in the second half of the year. Our approach to bidding will remain disciplined. While the first projects release during a market upturn typically tend to be very price-competitive, I want to emphasize that we will continue to be selective. The story in our markets and regions is very similar to the last few quarters. Our core run rate, OE, and after-market activity has been stable, as we prepare for the release of these larger-sized OE projects.

Considering the value we bring to our customers on the front end of major projects, our visibility into their progress continues to give us confidence that these projects are nearing the bidding stage and on the path towards ultimate release. The chemical market in particular is exhibiting strengthening conditions. Increased competitiveness of the US upstream and downstream chemicals are changing the dynamics of global competition. Nearly 100 shale gas-related investments have been announced in North America, with a value of over $70 billion, the majority of which are for ethylene and ethylene derivatives. The Middle East is also maintaining their drive towards downstream diversification, and the chemical strength in India and China continues within these countries as they drive towards energy and manufacturing security.

Moving to the oil and gas market, oil prices remain at levels necessary to encourage major investment in the positive long-term outlook for this commodity continuance. Saudi Arabia, Kuwait, China and Russia are planning low-sulfur fuel refinery projects, while North America is maintaining strong growth in pipeline construction, refinery upgrades, and gas processing, and gas to liquid plants to capitalize on advantaged natural gas and oil supplies. Additionally, we are seeing a shift in the coming opportunities in North America as Western contractors prepare to execute oil and gas projects that will remain here, particularly along the US Gulf Coast, floating production and storage operations at PSOs. Opportunities also remain steady in Brazil, Africa, and Asia-Pacific. Additionally, proposed growth in LNG production and export terminals in North America, and import terminals in Asia-Pacific, seemingly offset the slowdown in Australia, impacted by a slower China, national elections, and the high cost of local project execution.

Finally, Saudi Arabia, China, India and Brazil continue to drive major refinery projects. We see the power market as growing. China and India continue with their coal-based initiatives, while the Middle East is signaling strong future growth in both conventional and solar power. North America and Europe remain slow due to conservation and low growth in energy demand. Nuclear power is still in transition, although even Japan is considering restarting a number of plants. And globally, we see an increased focus on natural gas fuel combined cycle plants. The available power industry projects, however, continue to be driven by fixed-price turnkey terms, where pricing is the major consideration. Our efforts to build capability in our Coimbatore, India facility will help provide support to this market. And while after-market opportunities are also available in power, they are not as uniform globally, due to the shift occurring from coal to natural gas generation.

In general industries, we are experiencing strong growth in global fertilizer opportunities. Mining companies are investing more carefully of late, but we see good levels continuing in parts of Southern Africa, Latin America, and North America. We are also seeing encouraging signs in the desalinization market as industry experts expect new plant orders to arise over the next couple of years. Finally, our distribution business was solid, driven largely by orders supporting oil and gas projects globally. As we move into the second half of the year, I'm encouraged by the progress we have made over the last 1.5 years. And the propensity in the organization to continue its momentum as we look to capitalize on additional opportunities. With that overview, let me now turn it over to Mike Taff.

Thank you Tom, and good morning everyone. Following Mark and Tom's operational overview and business outlook for the remainder of year, let me discuss in greater detail our financial results. We continued to gain momentum in the second quarter, with strong leverage off solid revenue growth of 4.8%. Our year-to-date revenue growth of 4.2%, on a constant currency basis, is consistent with the low-end of our 2013 revenue growth target of 4% to 6%. The consolidated OE after-market sales mix was consistent with last year. I was particularly pleased that gross margin improved 150 basis points to 34%, driven by impressive margin expansion in FCD and IPD, up 280 basis points and 190 basis points, respectively, reflecting progress on our operational improvement initiatives. EPD's 20 basis point improvement was also a solid performance, considering the headwinds from SG&A and business mix as compared to the 2012 quarter. This overall gross margin improvement demonstrates the impact of our discipline and selectivity in our bidding process, which we will maintain during the expected ramp in large project releases.

Turning to SG&A, we saw an increase in SG&A as a percentage of sales of 50 basis points, driven by a few discrete charges this year totaling $4.1 million and a $3.9 million legal benefit last year that did not recur. Adjusting for these items, we saw a 20 basis point decrease in SG&A as a percentage of sales, driven mainly by thoughtful cost control and solid leverage. We will continue to focus on our longer-term goal of driving additional leverage from these costs as we target SG&A as a percentage of sales to be consistently in the 18% range. I am confident that the initiatives we are executing currently have us on pace to deliver on this commitment. The strong leverage in our business was demonstrated with an 11.3% increase in operating income, coming off the 4.8% revenue growth. Shifting to operating margin, an impressive improvement of 90 basis points to 14.8% was driven by 270 and 250 basis point increases in FCD and IPD, respectively. We continue to believe that we are on target to achieve our consolidated operating margin objective of 100 to 200 basis point improvement by 2014, as well is IPD's targeted margins of 14% to 15% by 2015.

It should be noted, however, that margins quarter-to-quarter can be volatile and difficult to forecast. On last quarter's call, we indicated that we expected this quarter to face margin pressure from an unfavorable mix, which did not occur, but now we expect that impact to affect Q3. Below operating income, a relatively calm foreign exchange environment resulted in minimal impact from the sequential mark-to-market of our currency hedges and balance sheet items in non-functional currencies. As many of you know, this is a pleasant change from recent quarters' earnings volatility as a result of decline, and continues to be an area of focus as we work to dampen the impact of foreign currency volatility on our results. In the meantime, we will continue to monitor FX closely. However, a strengthening dollar typically is a headwind for us. Our tax rate for the quarter was 29.4%, and we expect to be in the 30% range for the remaining quarters of 2013.

Turning to cash flows, we generated $75 million from our operations during the quarter. Capital expenditures were $27 million, and we repurchased $150 million of our shares, effectively completing our $1 billion share repurchase program announced last year. We have $536 million remaining on our current buyback program, and we will continue to execute on our strategy to efficiently deploy the balance sheet and return value to our shareholders. As in prior years, we expect to generate a significant portion of our operating cash flows in the second half of the year. Additionally, we continue to focus on our working capital as we methodically implement initiatives to address identified opportunities for improvement and work towards our goal of consistently generating annual free cash flow near our net income level. Turning to primary working capital, we saw some improvement in the quarter compared to the 2012 second quarter, with a reduction in DSO by 3 days, to 78 days.

Inventory turns were essentially flat with the 2012 second quarter. Again seasonally, these only modest improvements were not surprising. And we are still very much focused on our working capital goals of mid-60s DSOs and inventory turns of 4 to 4.5 times. We believe these targets are achievable with our continued effort. As I discussed last quarter, I'm confident that we are taking the necessary steps to achieve this level, and we expect continued progress to occur in 2013. Moving to our EPS guidance and outlook for the second half of the year, we are reaffirming our 2013 split adjusted earnings guidance of $3.20 to $3.53 per share, following our strong first half results, continuing operational improvements, and the solid performance of our run rate and after-market business. We continue to expect four-year sales growth between 4% and 6% on a neutral FX basis, after achieving the low-end of the range in the first half.

Turning to our spending priorities, as I mentioned earlier, we will continue to return value to our shareholders and remain committed to our disciplined approach to capital deployment. Importantly, we will continue to invest in our business to deliver profitable growth and solid organic returns, forecasting 2013 CapEx of $120 million to $130 million to further increase our worldwide capabilities. Other uses of cash we expect this year include pension contributions and scheduled debt repayments, but even combined, this amount is modest in comparison to the other priorities. We believe our capital allocation approach, with a targeted debt to EBITDA between 1 and 2 times, provides the flexibility to grow the business organically, return capital to shareholders, and invest in strategic bolt-ons. And will continue to produce solid returns for our shareholders. With that, I'll turn it back over to Jay.

Thank you, Mike. We have concluded our prepared remarks this morning, and Vanessa, if you are ready, we would like to begin the Q&A session.

(Operator Instructions)

Hamzah Mazari, Credit Suisse.

The first question is just on margins. You spoke of some margin pressure shifting into Q3. Could you give a little more color? Is that projects that are being delayed that are shipping out later? And was that an EPD? Any color you can give there?

Yes, we have talked about this before. If you look at the run-up in our backlog over the last year, a lot of that has been some of what I would call the projects we took before the One Flowserve initiative, and some of those are still there. And so it is really those that are running off. They will be primarily in EPD.

Great, and then just a follow-up on margins. Maybe if you could talk about -- after putting the COO structure in place a little over a year ago, maybe talk about what you have done? What is behind you already? What is yet to come in terms of IPD getting to that 15% margin rate? FCD, it looks like most of the low hanging fruit is behind you. EPD, it seems like there is still some legacy backlog to cycle through. Any color you can give on what is behind you, what is yet to come?

Yes, I will try to just do it a high level, maybe, in terms of innings, as people talk about it. I -- FCD has been performing at a very high level for a long period of time, and our COO, in fact, was running that. So I would say seventh-inning in that business. There are certainly still opportunity. But the focus there, Hamzah, is on growth. And so you have seen that. We will tell you what we're focusing on, and hopefully that is what we will be delivering. You have seen growth in FCD. That has been our priority. In the earlier stages in both EPD and IPD, is we've talked about before in IPD, we got off to a slower-than-expected start, but we are pleased with the progress. But there's -- our priority there is on improving, basically, the throughput in our facilities and efficiency to take advantage of growth.

And you have certainly seen the progress there third or fourth inning, probably the same in EPD as well. EPD also have another aspect of being a late-cycle business that -- there'll be a market aspect to it, but a lot of it is still what I would call within our control. So that is probably a good way to frame it up. These things certainly take time, especially in a the longer-cycle segments. So really if you think about it, we put the COO structure in place in the first quarter of last year, a lot of the processes were put in in the second and third quarter, so we are starting to see the benefits of that. But they are working their way through it. And I think that is one of the areas why we are encouraged is, when we look forward, we still have a lot of propensity in this business. We have a lot of opportunity to improve the operations. And again, FCD is a great example of that.

Great. And just the last question from me. I'll turn it over. If you could just touch on the competitive environment that you are seeing out there? Some of your European competitors are going through some restructuring. Other players being disciplined. It seems like you have a good opportunity to take share. Any comments on the competitive dynamic and environment you're seeing out there?

Yes. It's -- there are various things going on with competitor, but I think what you are seeing consistently, which we think is an endorsement for our industry, is a focus on flow control, and that really benefits the industry altogether. But you are seeing various things that are occurring. For the most part, what we are seeing relative to 2010 and 2011 is a thoughtful, competitive environment. And thoughtful doesn't mean anything other than everybody is certainly focused on margins.

Everybody is focused on what they put in backlog as opposed to where it was then. And that is typically what you see when you start emerging from these cycles. Keep in mind, the long cycle business has been basically in a soft patch since, really, the middle part, towards the end of 2008. So these are the way these things certainly cycle through, and you are certainly seeing that in the competitive landscape.

Great.

Charley Brady, BMO Capital Markets.

Just on the margin pressure that has moved from Q2 to Q3. What -- can you quantify that in any way, as to what that might hit EPD at?

I think this will really go back to our statement, we are not a quarter-to-quarter business. And for a whole host of reasons, some of these things can move, as they did even in this quarter from one to another. I think the -- for the most part, a lot of the, what I would call pre-One Flowserve initiative backlog has run off. As I said, you look at the year over year 8% decline. More than that amount is representative in some of the pre-One Flowserve backlog. But as we look forward, there -- I think, let's start from the framework of where we are right now. We have a better margin profile than we did last year.

And the fact is really, when the timing of some of these things come through, but what we don't want to do is start parsing here over the next couple of quarters what the margin impact will be. Just look at the general trends. You can see the underlying efficiency in throughput is improving. We had this quarter year over year of almost 70% contribution margin at the gross profit line on basically flat mix. That is indicative of an improving margin environment here. But these things can move them, Charley, in order of magnitude, you can think about $20 million or $30 million of a project that comes through at little or no margin. You can do the math as to what the margin impact will be.

Right. That is helpful. And just your commentary on the large projects that are moving in pre-seed scene, and into evaluation bid stage. Would you expect -- I know you are saying that you're going to book some in the second half. Would you expect some of that -- is some of that short enough that you recognize the revenue, or is this really all 2014 work that we are looking at?

You could see some revenue, maybe some engineering work, some early stages. But remember, these -- although I would say lead times are shorter than were in 2007 and 2008, for the most part you're still seeing lead times that are approaching a year on some of these things, so that will give you order of magnitude of when we will start recognizing the revenue. I think the focus, and it was in our comments, this year is really about improving the platform, moving some of the backlog through the facilities, and then to a certain degree share count. That is really what is driving earnings this year.

And can you give any more color on what types of projects these are. So an end markets or geographies of where you're seeing the bulk of this?

Yes, actually I will let Tom -- will comment on that.

The quick overview, and maybe start with just by region. In South Africa, the solar opportunities look pretty good. I'll just quickly go through each one and highlight the big points. Latin America, where we're looking like the FPSOs and some good mining and after-market activities. Asia-Pacific looks like FPSOs, power opportunities obviously in the combined cycle gas area, as well as refinery. Europe, we have some good after-market business versus last quarter, but I wouldn't say it's returned to the levels. Good Russian opportunities in power and oil and gas.

I would say FPSOs in the Netherlands, in the European area there is -- has been good in Q2. Middle East, we still look at those de-sal opportunities, as well as the power and the downstream chemical that go with the product diversification. In North America, as we have indicated in Q1, the pipeline business is good, good chemical business, as everything is shifting now to shale, shale/gas. And then I would say in Europe overall, via chemicals, there is a general migration on the chemical side to Middle East, Asia, and China, although we are seeing some stabilization on the chemical side of the business, relative to some of the economies in Europe improving. So I would say that's a quick overview.

And then lastly, nuclear. There is a lot of, I would say, ups and downs in nuclear, but Russia is pretty active with nine reactors going on. Sweden announced it is upgrading its nuclear fleet. However, in the US, some businesses have announced the move to gas, although we are looking at building a couple of nuclear plants in the US. And then obviously China, Russia, as well as India, proceeding on their nuclear units. So I would say that is a very quick regional overview.

Kevin Maczka, BB&T Capital Markets.

Wanted to touch on the projects again, and the visibility in the second half here. You commented, Mark, on the thoughtful, competitive set, but yet now we are also saying that the competitive bidding on these early jobs, it may be more competitive than maybe we were previously thinking. I'm just wondering, it sounds like your visibility and the way these projects are advancing is still there, which gives you comfort in the second half. But I'm just wondering if your visibility and your ability to win those jobs has changed at all because you are so disciplined with price and margin, which I think we all appreciate?

Yes. No, the competitive nature of these projects as it starts to cycle back is not new news. I think what we have seen, and obviously we have been bidding on some of these things, that's what gives us confidence that they are going to come, is just to remind you when -- and I think we talked about this on the last call. When these projects start to come back, and there is available capacity out there, it tends to be competitive around filling the capacity, and then they start to use price to rationalize that capacity. It is the way that every cycle work. So this is not new news.

Just one more on the after-market bookings that were relatively flat this quarter. Have you seen any change at all that you can detect in customer behavior there? Are there any deferrals in any way? I know you were up against a record comp, there, but any more color you can give on your after-market booking trends?

No. It is relatively flat, but we are talking about $0.5 billion of bookings. And you just look at the rolling four quarters, and you can see that we are growing this business in excess of what the net install base globally is coming online. So we still feel like we are getting good penetration and executing well. As you have seen in the past, any one or two quarters, and compared to the prior year, flat or slightly unfavorably. And I think we were talking about this in 2009. People were worried that it was going to start to tail off. And in fact what when you have seen is a solid, good mid- to high-single-digit growth over that period of time on a CAGR basis.

Okay.

Brian Konigsberg, Vertical Research.

I just wanted to actually touch on the recognition of revenues again for the large projects. I think previously, when we talked about it, you noted it was likely to be on a percentage of completion basis, given the size of these and how you have to work through the engineering. So if you are booking awards starting, maybe, late '13, and maybe that slips into 14, who knows? But is this going to be recognized more on an S-curve type fashion, where maybe the first 12 months or so, you were recognizing very little revenue, and then it spikes higher? Just trying to get a sense of how those will actually ramp?

They ramp with your costs. It is really the -- as you build cost into the project, you add your standard margin to that as you go through it, and that is basically how it builds up. You do make an adjustment at the end, but that is how percentage of completion works. And keep in mind, the percentage of completion taking a step back, is -- runs at or less than 10% of our overall revenue.

Right. So it is going to be more linear rather than an S-curve like we saw with EPCs?

They go with costs. Costs aren't necessarily linear. So it is as you start to build costs, you may have some engineering work and then do some spec design with the customer, and then you start to order some castings when the castings come in, the motors come it, as you can imagine. And keep in mind, and as we talked about before, in some of these big systems, 40% to 50% of the cost of that, the revenue base, comes from other suppliers like a big motor. So when that motor comes in, when you have a cost associated with that, obviously you will have a revenue component. So I wouldn't necessarily say it's linear, but it definitely lines up with the project.

Okay. And then just maybe over to Mike -- I'm sorry, Mike Taff. So just talking more about free cash flow. You guys' conversions has certainly lagged net income for many years now. So you guys are working quite diligently on your working capital accounts. I'm just curious, at what point should we anticipate that you actually do achieve net income-type of conversion? You actually -- I would think you should exceed that type of 100% conversion for some time. And it looks like that's probably is not going to happen in '13. But starting potentially next year, should we anticipate you start exceeding that level, and then you level off around net income thereafter? If you could just give maybe some more definitive timeline, as far as when we could anticipate that type of improvement?

I think as we said in our prepared comments, we've got a lot of initiatives underway. I think we are focused in the right areas. And certainly working with Tom's group, we are focused on -- the biggest components being receivables and inventories. But I think you will see some of that benefit starting, first half of next year, and then continuing through there. The long-term, as we get into 2014, that is certainly our goal is to have a consistent cash flow that is near our net income level. (multiple speakers) If you think about it from an order-to-cash standpoint on any project, with the One Flowserve initiative, what we did is started on the front end of the process, and frankly, working capital will tend to be what comes towards the end there. So what should give you confidence that we are going to get there is now you -- look now at the contribution margin and the gross profit line that is indicative of improving operations and execution. We do still have work to do on our operations. I definitely want to call that out. But then that should give you confidence that it is going to lead to working capital efficiency.

If I could just slip one last in. Just, Mike, I think you also said -- Mike Taff again. Sorry. I think you do say you were working on other initiatives to neutralize the impact of FX. Can you just comment on that? Are there some plans in place where we can start to see that transaction swing quarter-to-quarter and start to mitigate at some point?

Certainly we were pleased with the results this quarter, where we had essentially a minimal effect there. But yes, there is a number of things we are working towards. Continuing to look at different hedging strategies in all. And also looking at whether there is ways to account for our hedging programs differently that would really just try to eliminate as much of the volatility as possible.

Okay.

Nathan Jones, Stifel Nicolaus.

If I could just start with a clarification. I think, Mike, during your comments, you said 100 to 200 basis points margin improvement by 2014. I think in January last year, the goal was 150 to 250 basis points is that it change, or are you basing that over the different time frame?

It is over a different timeframe. We -- remember when we put the 150 to 200 basis points? That was a year ago January, so that was coming off of 2011 results.

Okay, so it's off 2012 results?

Yes, we improved by 50 basis point in 2012.

Okay. Cool. Mark, thinking a little longer-term and a little more strategically, it seems like we are getting the portfolio into better shape. One Flowserve is having its effect. When you think about M&A, obviously Flowserve has not been very active for quite some time. Thinking about potentially larger deals, or adding another platform, or something more major on the M&A front. Can you talk about what your appetite for that might be? And what kind of time frame you might think about?

The timeframe is probably dictated more by the market than anything else. But I will say this. I think our focus is, if you consider the size and scale of our business, we don't feel at this point that we need to go and make a huge consolidation play in the industry. Consolidation, be it more where you are taking capacity out, consolidating costs, and basically substantial integration. Frankly, what we have done between 2009 and 2012 was, with all the changes we made in our business, was almost like a large acquisition. And so we are very focused on continuing this momentum. Having said that, there have been and the opportunity set is certainly a little light right now in the industrial space, but there have been and we think will continue to be opportunities of size that we would classify as a bolt-on.

A bolt-on being where we bring it in as a business and leverage our sales platform, our after-market platform, certainly our leadership team that we have in place right now, or even something on the adjacent side that is focused around rotating equipment, we can drive our end-user strategies. That is how we think about it. And I can tell you, as we continue to improve operations, it gives us increasing confidence of being able to integrate one of these bolt-on acquisitions. So I think from our standpoint, if you look at it, are -- we want to make sure we maintain capital structure flexibility to take advantage of opportunities. But we also want to make sure that we drive improvement to this platform and don't do anything to set it back. But from a huge transformational industry consolidation play, we just don't see that that makes sense at this point.

Okay and one for Tom. Tom, orders in flow control have bounced back nicely after some negative growth last year. Is that growth coming short cycle through distribution, or more at project basis? Does that feel like a bit of an early cycle period for flow control? And could we see that continue for a few more quarters?

In Q2, the after-market business was up in flow control, so that is one area. And I would say in general, it is the larger projects. The FPSOs in Brazil and out of Korea and off the European coast, as well as we have seen some good nuclear parts business for North America and Southeast Asia. And then I would just say oil and gas projects in the Middle East. Those are the main areas. (multiple speakers) What you are seeing from that is -- I think to your point, is a little bit of an early cycle read. And you are seeing it with other process companies as well. But I don't want to -- you said we haven't really made -- been too active in acquisitions. We acquired Valbart three years ago to get our presence in the oil and gas industry, and we have consistently seen the benefit of that acquisition in our results over the last two quarters.

So just in terms of distribution in flow control, how has that been over the last couple of quarters?

The distribution business was up in this last quarter. It was basically in the oil and gas area and the chemical market. And again, a little distribution increase we also saw in China, based on the last two or three years worth of the OE projects that we started to place down in there. And then we have had just a small amount of distribution on the US power market, but that was up in Q2.

Scott Graham, Jefferies & Co.

I wanted to ask on the cash flow side, Mike. I'm looking at the cash flow statement on the press release, and the year-to-date investment in inventory and receivables certainly have improved. It seems to me that more of the working capital issue is a matching, at least in the first six months of this year, of what you are doing on the asset side versus what you're doing on the payable and accrued liabilities side. That is just a number. Is that a fair statement, and maybe what are you thinking on that? What is the plan to improve that?

Certainly, I think on the accounts payable side, you saw some usage on accounts payable. But I think that is just more timing than anything, Scott, from that standpoint. And on the accrued liabilities side, it matches with what we have been talking about. One of the large users year over year and for the first six months was deferred revenues. And as we've talked about the lack of the large projects bookings over the last several quarters, more of the run rate business and after-market business, you just tend to have less of that deferred revenues, that upfront payments at all. So that makes sense with where the bookings have been the last several quarters. I think as we get -- the long-cycle business starts to increase into the second half of this year and next year, you will see that turn and be a bit more positive.

Got you. Okay. And I also wanted to maybe talk again about the projection of -- your guys' projection of when these things start to -- these projects start to get released and when you can start to bid on them? And maybe this is more of a question for you, Mark, that anyone. But also, I would certainly, any chiming in would help from the other two EPC guys in the room. Is the turn, the potential bottoming of steel prices, something of a catalyst for when projects get released? Essentially where I am going with this is, do end-users say, okay, steel isn't declining anymore, maybe it is starting to turn the corner, certainly has bottomed, is that a potential catalyst for projects?

No, it's -- we -- if there is a view of rampant increase or extreme increase in material costs like you saw in '07 and '08, people were hurry to get their capacity in place to process that, like you saw in the mining industry with some of the materials. But steel may be an indicator of general economic outlook, which will play through. But at this stage where these projects are, steel prices in itself are not going to drive what brings them this quarter, the next quarter. You think about some of these projects that we are talking about that we see on the horizon are due to go into commission in 2015, 2016 and 2017. And so, if you take a step back from there, they already, in a sense, have their timeline that is built out. They need that capacity online, power refinery or whatever it may be, in those periods of time. That is why they can move a couple of quarters as they move through it. But steel -- and you see that with any natural resources, because of the lead times of this capacity, and sometimes where we are in this stage with the pre-feed and the feed work done, the amount of investment that is already in it. That steel price or a marginal move in gold, a marginal move in oil, anything like that is not going to really change the pace at which these things go out.

That is fine. That is really all I had with the, I guess, maybe the one -- I don't think that you guys would've called out any types of gains or discrete losses on disposals or anything like that. You would've called that out, right? So I'm assuming none this quarter?

Only thing -- yes. No, we didn't. I think the only thing that we talked out discrete, I think, was in our press release. Pretty minor.

Very good. All right.

Jamie Sullivan, RBC Capital Markets.

Mark, your commentary around the cycle, I just had a follow-on there. You mentioned the cycle has its pattern. This one is no different. What does seem different is Flowserve and the discipline and selectivity that has been happening. So I guess the question is whether -- are you going to participate at the same level this cycle, or are you going to pick your spots at certain points of the cycle? Just wondered, your thoughts on that.

I think in general, as a Company, our -- where we were versus the last cycle, far more disciplined and certainly improved execution. I think you should expect that to continue. Having said that, I look at commentary from some of our competitors and I think they are talking about increased discipline as well. So we wouldn't underestimate them by any stretch of the imagination. But I think in general, if you're asking what has changed, yes, there is certainly going to be more discipline. And if you look at -- there is a lot of changes this cycle versus the last. One Flowserve being one of them.

The disciplined approach, the way we can utilize our capacity under our lead product, secondary product. We actually, in effect, have more and more efficient capacity to deal with project opportunities. Obviously, we are in different locations around the world, where the opportunities are. So there is -- it is a long conversation that I'm -- next time I see you I'd be happy to have with you, around what has changed during that period of time. But you should expect continued discipline from us through this cycle. And a lot of the reason is, if you look at what has really been carrying us for the last three or four quarters, it has been the after-market and run rate franchising. The improving operation is driving earnings growth. Great leverage on the gross margin now and even all the way through the operating line.

That is helpful. A follow-on with the free cash flow discussion, getting to near-net income. Mike, I just wondered, if you do win these -- some of these large projects, let's say, in the back half of the year, early next year. Knowing some of the working capital requirements on the project business, do you still feel you can hit that 100% of net income next year with that mix shift?

I think the key there, Jamie, is just really focusing on our terms and conditions. And that is part of our this month's selectivity. It is not just the margins we are putting in the job. Terms and conditions are very important. And with that comes billing milestones and things of that nature. So that is something that we continue to stressed with the organization, and it is just important to stay in line with the customer there with our cash flow requirements on these big project.

Great, and then one last quick one if I could. EPD, and there was a mention of bad debt expense increase. Could you add some color there, magnitude, what the driver was?

It was one customer and it is basically all taken care of. So it's not something that you will see that would recur.

And so that might actually help margins going into the third quarter?

Certainly, I'm not sure we will get recovery from that one particular item, but it was relatively small.

Okay.

But it was a development project that we were working on and all, so -- but it is taken care of.

Okay.

Steve Fisher, UBS.

Tom, you gave a nice outlook on the regional opportunity set. Do you have any sense of which regions are more advanced in their award process and may come in sooner versus those that are maybe going to be a bit later?

Certainly if I looked at Europe, I would just say in general, Europe is, I would say, moving out of some of the economic situations that they have had over the last 18 months. And then I would say in other regions it is very dependent upon the type of product within the industry. So for instance, in -- obviously in the US, you have pipelines, which is maybe different than, say, your coal-fired power plants, which is going through some changes. And certainly FPSO seems to be, I would say, prevalent at -- certainly in different parts of the world, Brazil and off the coast of Europe and so on. I would say, it really depends upon a number of different factors.

Okay. So it sounds like it is still fairly wide open as to where these few projects could come from.

Yes, I would say, the good news on the power side is that we're seeing a lot of power activity, different than what was there in the past, as one of the first, I would say, of these type of projects that previously were in feed and pre-feed. We are seeing them transition now to an active bidding/further potential buying stage after this bidding stage that we are going through right now.

Okay.

I think the answer to that question, and the way we go through it, there's probably some general regional overlays, but the way Tom goes through these things specifically should highlight why we -- and we know and have an understanding these products are going to come on. Because they are very specific to the type of activity that is going on. But in general, I think our commentary around the regions was, Europe is stable at low levels, North America, you're going to see -- they keep talking about a manufacturing renaissance. And relative to Europe, I do want to point out, four years ago the commentary around North America was manufacturing was leaving. It wasn't going to ever recover. Things weren't going to be the same. And here we are and it is quite different. I wouldn't expect anything too different out of Europe.

Okay. And then in the second half, I guess a question along the same lines. Are you thinking that these awards had come to the marker and be just one-offs? Or might it be a more robust flow of projects coming to market? Or is that more of a 2014-type situation? Or is it just too hard to tell on the timing of these bigger projects?

It's probably fair to say that a more general project activity will be 2014. They are all one-off, frankly, the way we work them. But I think more of a general project type activity is going to be -- across the board is going to be 2014.

Okay, great.

William Bremer, Maxim Group.

Nice efficiency this quarter, gentlemen. Very nice. This morning, one of your competitors had to adjust their guidance due to pretty much similar commentary from you guys, in terms of a lack of large -scale projects. And some of them shifting to latter periods, impacting the remainder of '13. Should we be expecting, based upon your guidance, that we should be more towards the lower end due to this, at this point?

Bill, we don't -- we certainly don't give guidance within the guidance. And my commentary earlier around this year was the increased efficiency, which you commented on at the beginning, and share count is really what drives earnings this year. But one other thing relative to that competitor, who is a great presence in oil and gas. They are more vertical across the oil and gas industry. We are more diversified across different sectors than they are.

No, that is a given. Agreed. My second question is, has there been any type of repricing or cancellations in the backlog, currently?

Repricing, again, if you think about it, we have firm contracts when we go into these things. That is typically not a big issue. The pricing activity occurs before you get the contract, not necessarily after, and cancellations haven't been anything out of the ordinary.

Good to hear. And then, Tom, you mentioned -- you called out some of the pipeline activity. Can you give us a sense of -- primarily, is it shales? We really haven't seen too much on long-haul pipe, especially here in North America as of yet. But maybe just give us an idea of the contents of the pumps involved, and your exposures to pipelines in general? Just a nice little overview, if you may?

Yes, I would say in general, you are correct. It is not necessarily the long overhaul pipeline business that we are talking about. Most of this is associated with the shale and the liquids business. In a lot of cases, it may be up-rates to an existing facility, also on the after-market side of the business. So I would say it's some new, and it also up-rates to existing systems on the pipeline business.

And how would you characterize your year over year, in terms of this particular segment? Would you say you are running 20% or 30% higher year over year at this point?

I would say the run rate business -- pipeline business, I would say, is very similar, and has been -- it grew nicely last year, and the same thing this year overall as an industry. So I would say, it's staying at the same levels in terms of an overall industry itself, year over year.

Okay, gentlemen.

Joe Radigan, KeyBanc Capital Markets.

Just one question. Tom mentioned $70 billion in shale investment on the radar. Are you similarly able to quantify the magnitudes of projects you're tracking on an overall basis globally? Just to give a sense of order of magnitude for the opportunity that is ahead here. And then how do you think about capture rate, either historically or what is your target going forward?

We do track all that, but we don't discuss that, necessarily, publicly. The general information around project opportunities is from third-party sources, which we use as well is available, but in terms of what we are targeting, there are certainly plenty of opportunity over the horizons over the next couple of years, but we don't go into that detail.

Okay, that is fair.

David Rose, Wedbush Securities.

Two final questions. I was hoping that -- if we can think about the -- your commentary around revenues for next year, or at least you said this year was a year of -- really a year of execution and discipline and then next year was a year of growth. This year, you were talking about 4% to 6% top line growth. You indicated, Mike, that you are at the bottom end of that. So, in order for you to exceed that number next year, what sort of bookings expectations do we have to see for the back half of this year on a year over year basis? That is one, and then I have a second follow-up.

Obviously, for growth next year, some pickup this year or next year in the order book will drive revenue growth in the projects. But also, and I think equally or more important, continued growth in our run rate and after-market business, like you have seen. One thing to keep in mind with these projects when we book them, is that is revenue you take over a longer period of time. And -- but the shorter-cycle run rate and after-market business, that tends to manifest itself in revenues quicker.

So my point is, a company can have a significant increase in big project work that goes into the backlog, but may cover revenue over a 1.5 years. So that growth will be muted over that period of time relative to the booking growth in any one period. But the run rate business and the after-market business can grow quicker, and that is why we stay very focused on that. If you look at, over the last couple of years, we have grown those businesses. Those tend to be more stable margins, after-market is high-margin business. Hopefully that will give you some color.

That helps. Obviously, you had difficult comps, as noted in your after-market business. So we would need to see a progression of that after-market growth, along with stable OE bookings. Is that pretty fair, in order to see growth above this year? Okay.

And just don't look at any one quarter. Because again, going back to the after-market, this is over $0.5 billion of after-market. We weren't anywhere near this size of an after-market business four or five years ago.

Sure. No, I appreciate that, and I think you're doing a great job on that. The other question is, the IPD margins were very impressive. And again, this goes back to your point about the after-market business. The bookings were down significantly, both in OE, and then they were down for the after-market for that business. So you lose some of that operating leverage you have. You're obviously executing better. So is it intuitive, then, that the margins -- you take two steps forward, one step back on the margins, that is sequentially? Maybe it is a third or fourth quarter, we should see some decline in that margin, on a sequential basis?

As your -- I think the way to look at margins -- your one -- two step forward, one back may be when they're operating more efficiently, in that the marginal impact of mix is really the primary driver of margin impact. When you are improving your operations from where they are. Believe me, they've got a ways to go. It is more about your throughput and your execution, which has been a priority. So if you look year over year, we focused them on the run rate business. They had a couple of what I would call medium projects in the second quarter last year that came through their bookings. But really, it has been around making sure that they are most efficient in taking good care of their customers. So I think over the near-term, as we continue to improve this business, I think more of the margin profile is going to be over improving the operations and getting better efficiency. And then down the road, we will get to the discussion of OE after-market mix, OE growth, after-market growth that will start impacting margins. That is where we want to be with the business. If we get all of our businesses that way, like we are in the flow control division, then it is a different discussion.

So then I shouldn't expect the IPD business margins to decline, given the decline in the bookings number?

In and of itself on the bookings, no. They can have mix issues, they can certainly have things from quarter to quarter. We are going to 14% to 15% in this business over the next 1.5 to 2 years. That's still a ways to go.

Sure. Okay. That's helpful.

One quarter to the next, things can change. We keep telling you, be careful to try to evaluate this on a quarter-to-quarter business.

Yes. I know. We just try to frame, obviously, on a quarter-to-quarter basis, but that is helpful.

And that was our final question. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.