福斯 (FLS) 2013 Q4 法說會逐字稿

Welcome to Flowserve's 2013 earnings conference call. My name is Adrian, and I will be your operator for today's conference call.

(Operator Instructions)

I will now turn the call over to Jay Roueche, Vice President, Treasurer, and Investor Relations.

Thank you, Operator, and good morning, everyone.

We appreciate your participation in today's call to discuss Flowserve Corporation's financial results for the fourth quarter and full year of 2013, which we announced yesterday afternoon in our press release and form 10-K filing.

Joining me on the call this morning are Mark Blinn, Flowserve's President and Chief Executive Officer; Tom Pajonas, Chief Operating Officer; and Mike Taff, Chief Financial Officer.

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 2 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 material contain forward-looking statements that are based on forecasts, expectations, and information available to Management as of February 18, 2014. 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 in our filings with the Securities and Exchange Commission, including our form 10-K filing for the year ending December 31, 2013. All of these documents are also accessible on our website in the Investor Relations section.

Finally, 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.

Overall, I am pleased with our operating and financial results for the fourth quarter and the full year of 2013. Our employees remain the key to our performance, and we are all committed to delivering value for our customers and shareholders. We are One Flowserve, continuing to build on our performance culture and challenging ourselves to consistently exceed our customers' expectations.

Considering our results announced yesterday, we are essentially in line with the upper end of the range we provided a few weeks ago. Today I will speak more to some themes and major strategies we have implemented, their impact on recent results, and our expectations for improving performance in future periods.

For several years now we have focused on operating and financial improvements within the four walls of Flowserve. And that work continued in 2013 and will remain an area of focus in 2014 and beyond. These efforts have generated substantial returns with strong contributions to gross profit and operating income, driving the third consecutive year of double-digit EPS growth.

One of our early internal strategies was One Flowserve. I have regularly referenced it, but it is ongoing importance shouldn't be overlooked.

As a pure play flow control company, we increasingly recognize synergies between our segments and product offerings. Our progress and opportunities include better utilization of our global network of quick response centers, offering our full portfolio to key common customers, measuring performance metrics consistently across the organization, implementing best practices and operating with common processes, and leveraging our corporate functions in centers of excellence like R&D and supply chain.

While the propensity for further operational improvement remains, our progress on this initiative has already resulted in strong earnings leverage and margin expansion. During the year our end markets experienced slow but accelerating growth, and we remain confident that capacity expansion in the energy markets is on the horizon.

By geography, we remain encouraged in North America both for original equipment and aftermarket. We saw several North America projects awarded to EPCs for chemical and LNG projects. This movement is a good leading indicator for our original equipment work.

The North American aftermarket was sluggish in 2013 as refinery maintenance delays served as a headwind to the region's aftermarket work. However, we do expect to return to more typical maintenance schedules this year, and the announced activity along the Gulf Coast supports this view.

Europe continues to demonstrate stability and indications of modest growth. Assuming currency and political stability, Latin America should see increased infrastructure spending over the next few years.

In Russia and the Middle East, investment to expand, diversify, and update their capacity is needed, and we have seen a few larger projects move into the bi-phase for our products in the Middle East. Macro growth in Asia is expected to continue, and our objective is to increase our presence. In all regions, similar to prior cycles, we see the early project opportunities as very competitive.

Another strategy of initial focus is our discipline around the bidding process. Here, too, we have made significant improvements to ensure that the new work maintains or improves the quality of our backlog. Even as we have experienced a soft multi-year cycle for large project work, the results of our improved bidding discipline are evident in the higher-quality backlog rolling through our 2013 results and are demonstrated by our strong fourth-quarter bookings growth and, really, the order levels we achieved throughout the entire second half of 2013.

As a result, the quality of our backlog is better today than it was a year ago. In particular, our run rate original equipment bookings have grown nicely and created a stable, higher-margin sales platform along with our aftermarket franchise. Given that anticipated large project activity did not materialize into orders during 2013, our efforts to increase this run rate business delivered solid overall original equipment bookings growth.

From an aftermarket perspective, we delivered strong fourth-quarter and full-year bookings. Despite a decline in our largest aftermarket region, North America, the overall level of bookings further validates the actions we have taken on our strategic localization initiatives, which facilitate our customers achieving increased uptime and efficiency from their process equipment. We also continued to invest in our end-user strategies to better serve our customers, including the opening of two new QRCs.

I was also pleased to see FCD deliver 9% bookings growth and increase sales in the aftermarket area. It demonstrates another example of the benefits of our One Flowserve flow control platform.

Our efforts growing the run rate original equipment business in the aftermarket franchise delivered on the mid-single-digit revenue growth guidance we issued originally in 2013. This modest top-line growth combined with an improving backlog and a solid operational execution produced meaningful margin expansion.

A key to our 2013 progress included IPD's 12.2% operating margin, a 180-basis point increase from the 2012 levels. This improvement keeps IPD on pace towards its 14% to 15% operating margin target by the end of 2015. With its platform strengthened, our focus now turns to growth in IPD.

Our goal of consistent business growth and operational excellence to drive value is core. But it also dictates that asset optimization remains a key priority. We took a number of actions in 2013, including the first quarter's joint venture transaction in FCD as well as this quarter's realignment investments, which will generate quick returns and more efficiently utilize our assets. In addition, we continue to target inorganic bolt-on acquisitions. In the fourth quarter, we complemented our pump portfolio with sealless pump technology through the acquisition of Innomag.

Similar to prior bolt on acquisitions, we targeted a technology gap with the opportunity to leverage the acquired products across our worldwide sales organization and capture the aftermarket sales opportunities of a previously underserved install base. The operational excellence initiatives we have implemented over the last few years are central to this bolt-on strategy, as we have increased our capability to efficiently manage and integrate bolt-on opportunities.

Even as more and more parties have become interested in the flow space, we believe our disciplined approach to M&A is effective for Flowserve, our customers and shareholders. When evaluating investments which include organic growth initiatives, divestitures, realignment initiatives, or acquisitions, we operate our business with an owner's mindset to drive long-term shareholder value.

We remain committed to disciplined capital allocation, returning value to our shareholders within an efficient capital structure including our targeted debt to EBITDA ratio of one to two times. During the year we returned $535 million to shareholders through dividends and share repurchases and took advantage of attractive debt markets to obtain low-cost longer-term capital.

Turning to 2014, I am encouraged for this year and beyond. While I'm pleased with the progress we made in 2013, our ability to build on the operating momentum we have achieved over the last several years is substantial, and I believe tremendous propensity remains. We continue to expect significant investment and new capacity in the energy markets, but will focus near term on those items we can impact. We believe we have further earnings opportunity for improvements in customer service, on-time delivery, low-cost sourcing, reduced cost of quality and working capital improvement.

We will continue to build on our $2 billion aftermarket franchise while growing the run rate original equipment business. We will invest in our people and advance our culture of performance. In summary, we expect to profitably manage and grow our business to create long-term value for you, our shareholders.

Now let me turn it over to Tom.

Thanks, Mark, and good morning everyone.

I am also proud of the operational progress we made in 2013 and over the last few years. Our operational strategies and initiatives including One Flowserve, focused on the customer, disciplined process improvement, and performance culture, have driven synergies across our segments. The results of these initiatives are evident in our strong operating performance, which drove impressive gross and operating margin expansion for 2013 in spite of a lower aftermarket sales mix headwind.

Our disciplined investments in the operating platform are delivering returns and demonstrating improvements in a number of areas, including quality, with over 2100 CIP-trained employees; supply chain; our focus on the customer through our project management process; our aftermarket service capabilities, product innovation, and our research and development process; project pursuit, including sales proposal initiatives; the new sales organization and focus on our global customers; and our asset utilization for our lead product and secondary product centers.

Our central focus is developing the cultural performance that consistently delivers notable results. I'm confident that propensity remains for an ongoing operational improvement. Opportunities remain to pull levers previously outlined and others across our broad product, geographic, and industry exposures.

Last quarter I highlighted a reduction in our past-due backlog metric as we drove it to the lowest quarter and level since 2009. This solid performance demonstrated the impact of our ongoing operational excellence efforts. However, in our continuous improvement culture we recognize that our work is never complete. I am pleased to report that during the fourth quarter we made further advancements and reduced our past-due backlog percentage to near Best In Class levels at year end.

This performance helped drive the related increase in inventory turns and generated real cash flow improvement. It also shows that by focusing on and managing key performance metrics we can achieve significant progress. Similar opportunities remain in other aspects of working capital such as DSO, and I am confident that with our continued focus on the process and the tools we provide our people, we will make solid progress in 2014 and beyond.

Turning to our order activity, we remain optimistic. Strong fourth-quarter bookings were up over 17% year over year on a constant currency basis, with growth in all regions including notable activity levels in Asia Pacific. Europe appears to have stabilized in 2013, and we delivered bookings growth in that market for the first time since 2010. Original equipment orders were up over 23% on a constant currency basis as momentum in all of our segments improved.

Consistent with the rest of the year, the impressive fourth quarter OE bookings did not benefit from the anticipated larger project activity but was a result of our focus on run-rate work. This improvement in OE run-rate environment over the second half of 2013, combined with the EPC awards we have seen, are positive indicators that the market is turning.

We remain confident that a number of large projects are building in the pipeline, and we look for the pace of awards to increase through the year. As we have emphasized, the first few larger project opportunities that we have seen were competitive both in price and terms, and we expect the first phase of these projects to remain so.

Our approach to bidding, however, will remain disciplined, as we expect order momentum to build. Flowserve is also able to focus the customer on the benefits of our technical capabilities, on-time delivery performance, and localized presence. Our disciplined approach to project pursuit and bidding that we have deployed over the last two years has proven successful, and it remains critical to the overall quality of our backlog.

Now, summarizing our end markets. The oil and gas market remains strong, with current oil prices and the positive long-term outlook supporting major investments. New refining capacity investments are expected in the Middle East, Asia, and Latin America. Additionally, Kuwait's long-delayed clean fuels project has recently been awarded to EPCs.

North America continues in this strong growth in pipeline construction, refinery upgrades, gas processing, and gas-to-liquid plants, to capitalize on advantaged natural gas and oil supplies. Longer-term opportunities in Mexico should improve following recent policy reforms expected to increase production levels. From an aftermarket standpoint, we expect increased activity in the Gulf Coast following refinery maintenance deferrals over the last 12 to 18 months.

The chemical market also remains strong, and the outlook is very positive, as plants renew ethane capacity in the Gulf Coast advance. The announced level of North America's shale gas-related investments is impressive, valued at over $70 billion. And the majority of this capacity is destined for ethylene and ethylene derivative projects, as the US has joined the Middle East as a low-cost feed stock leader. The Middle East is continuing their efforts toward downstream diversification, while Asia and Latin America are reassessing the chemical development plans based on competing opportunities in the US.

Moving to the power market, we see it as growing, driven by fossil-based initiatives in China and India. The Middle East also signals strong future growth both in conventional and solar power. North America and Europe remain slower due to conservation and low growth in energy demand. While nuclear power remains in transition, we see continued development in China and discussions of new capacity in some regions of Europe.

Additionally, opportunities continue in upgrades, uprates, and recertification of aging existing plants. Finally, we see an increased focus globally on natural gas combined cycle plants, with US expansion potentially negatively impacted by pipeline constraints.

Our general industry markets continue to see high activity levels in global fertilizer projects. Mining companies are investing more carefully of late, but we continue to experience good levels of activity in parts of southern Africa, Latin America and North America. Finally, our distribution business, primarily valves, continued its solid performance with increases year over year.

Wrapping up, our operational progress over the last two years is significant. Following the strong finish in 2013, I look forward to 2014, encouraged by the propensity for the organization to continue this momentum, make further operational progress, deliver on our quality backlog, and capitalize on expected opportunities as support from our end markets accelerates.

With that overview, let me now turn it over to Mike Taff.

Thank you, Tom, and good morning, everyone.

Mark and Tom have pretty well covered our operational overview and business outlook, so I will discuss our financial results in greater detail and then provide some color on our 2014 guidance.

We finished the year strong. With sales of nearly $1.4 billion in the fourth quarter, we grew revenue by over 5% on a constant currency basis. For the full year, constant currency revenues increased by 5%, or right in the middle of our 2013 revenue guidance range.

Turning to margins, even with the 2% mix shift towards original equipment and realignment charges, fourth quarter gross margins improved 20 basis points from the prior year to 33.9%. Excluding the impact of realignment, the improvement was 60 basis points compared to the prior year.

For all of 2013, we delivered a gross margin improvement of 80 basis points despite a 1% OE mix shift. Excluding the impact of the fourth quarter's realignment charges and cost of sales, gross margins improved 90 basis points.

Turning to SG&A, for the full year it increased 10 basis points as a percentage of sales, to 19.5%. However, looking at it more normalized, it was down 30 basis points after adjusting for the fourth quarter's discrete charges and the $14.3 million of SG&A benefits in 2012. This is an area we have focused on, and we are pleased that over the last three years our normalized SG&A spending has remained pretty flat.

We believe opportunities remain in the system and as such, will continue to work towards our goal of an SG&A percentage of 18% over the next few years. With gross profit improvement and our focus on SG&A, we delivered a 110 basis point improvement in operating margins during 2013, to 15.3%. At this level, we achieved the goal we set in early 2012 for a 150- to 250-basis point margin improvement by the end of 2014, from a 2011 base. However, we still have this year remaining in our goal timeline, with continued opportunities for further improvement, so we're not done yet.

Finally, our fourth quarter tax rate was 25.9%, which was lower than our previous expectations, as we were able to realize the benefit of some favorable resolutions of tax items. Our full-year rate of 29.5%, however, was generally in line with our initial tax rate guidance of 30%.

Turning to cash flow, we finished the year strong, as is typical with the seasonality of our business. We generated $378 million in operating cash flow in Q4, bringing our full-year cash flows from operations to $488 million. While I am please with cash flow generation for the year and the quarter, we still stay focused on this area. Our goal remains to consistently generate free cash flow near our net income level.

Our 2013 CapEx was about $139 million, north of our rate of depreciation as we continue to invest in organic opportunities for the long-term growth of our business. During the year we invested in new capacity in China; a new facility in Brazil; expanded capacity in India, the Americas, and Europe; new QRCs; and expanded nuclear capabilities to name a few.

Finally, we continued to execute on our strategy to efficiently utilize the balance sheet, while at the same time pursuing profitable growth investments and accretive bolt-on acquisitions like Innomag. We returned over $535 million to shareholders in dividends and share repurchases during the year, and issued $300 million in long-term notes in the fourth quarter, as we maintained our targeted debt to EBITDA ratio between one and two times.

Turning to working capital, as Tom highlighted, we made good progress on inventory. We continued to reduce our percent of pass-through backlog and drove inventory turns to 3.5 times, a solid improvement over prior year's 3.2 times.

While we delivered year-over-year DSO improvement in each of the first three quarters during 2013, the fourth quarter was flat with prior year at 75 days. I am disappointed in this pause in our progress, but I remain convinced we have the right plan and people focused on driving improvements into the mid-60s.

We continue to deploy CIP assets across the business to evaluate and improve our processes. I am confident we are taking the necessary steps to achieve our working capital goals and look forward to return to meaningful progress in 2014.

Moving to our 2014 outlook and EPS guidance, we are reaffirming our 2014 EPS guidance of $3.65 to $4, which we had originally issued a few weeks ago. Similar to recent years, 2014 should reflect traditional seasonality, with earnings weighted to the second half of the year. Absent any transactional gains, such as those that benefited EPS in the first quarters of 2012 and 2013, we would expect over 80% of our full-year 2014 target range will be generated during the final three quarters of the year.

In addition, we will continue to execute on our strategy of efficiently deploying capital, including annually returning 40% to 50% of our running two-year average net earnings to shareholders through dividends and share repurchases. At year-end $384 million remained available under our current share repurchase plan authorization.

Earlier this week our Board approved a 14.3% increase in the quarterly per share dividend, further emphasizing our commitment to shareholders. This represents the fourth consecutive annual double-digit increase. This year we expect to invest $130 million to $140 million in capital expenditures to continue profitably growing the business organically and to further increase our capabilities around the world.

Lastly, I would like to remind you that we will host our analyst day in Raleigh, North Carolina, on March 26. This year's event includes a tour of our large engineered valve manufacturing facility in that city, and we look forward to seeing many of you there. Please reach out to Mike or Jay if you are interested in participating and have not received an invitation by the end of this week.

With that, I will turn it back over to Jay.

Thanks, Mike. Operator, we have concluded our prepared remarks this morning, and would now like to open the call for questions.

We will now begin the question-and-answer session.

(Operator Instructions)

Charley Brady, BMO Capital Markets.

I just want to focus on the industrial products division for a second, and the margin performance there was certainly better than we were looking for. You called it out on one of the slides, on the segment, but I wanted to just get a little more granularity on where that business is going. You're moving up, and you're getting pretty close to your target there.

Do you see a runway beyond your initial target? I know you are not putting guidance out there right now, but maybe give us a sense, because it sounds like you're getting there a little maybe quicker than certainly we thought you were going to. How much of that we saw in Q4 is permanent, and how much of that maybe was driven by a seasonality factor?

First of all, Charley, I'm glad to be on this side of the conversation, because two years ago we were telling you it was going slower than we anticipated It has been pretty much in line, and, as you know, our focus has been on fixing this platform, so it's fair to say we have not grown it as quickly as we could have, because it wasn't where we needed it to be.

The second thing is, when we get this thing to 14% to 15%, then we can talk about where from there. We are focused on getting it there first. Q4 -- you can see in many of our divisions, typically you get good fixed cost leverage. It tends to be our highest volume on the revenue side, so that will tend to benefit margins during that period of time. So, it's really better to look at just the annual margins in terms of improvement, because we do have seasonality in our Business.

If you think about it, we ship to a lot of national oil companies, parts around the world, where they have annual budgets. And they either get the equipment in at the end of the year, or they basically start all over. That's what drives the seasonality.

But we are pleased with the improvement. It was one of the reasons we were encouraged and brought Innomag into that platform, because we think it's not where it needs to be, but it has certainly improved.

And the other thing I can tell you, and it's very basic to our Business: Margin is an indication of how well we are executing, or not executing for that matter. And when we execute well, our customers give us more orders. So, what we're doing now is we're focused on growing that platform.

On the back of that, the Q4 bookings were up pretty strongly. Maybe you can just, for all three of the business segments, your top-line guidance is 3% to 6% for the year. Can you give us a sense of: in line, above, below, across the three segments?

We don't break our revenue down by segment at all, Charley. Let's just stick with the 3% to 6% across the board.

I think the areas of focus that we talked about over the last couple of years, and it's pretty consistent, is our valve business has been operating very well, and we are really driving for growth. And even last year, how do we optimize and better penetrate the markets? On IPD, there is still some improvement; we want to drive growth. On the EPD side, we are really focused on growing that aftermarket platform and the run rate, and being very disciplined on these projects.

What I mean by that, just to give you some color, and I made this comment before: You go back to 2010, and your focus was on absorption because you didn't know when your markets were coming. As we start to see them come, you can be much more disciplined and focused on making sure your backlog continues to progress over the period of time, especially when you have the run rate and aftermarket business that we do. It gives you the opportunity to be a little more flexible as to when you take these projects in.

So, as you think of our three platforms, solid operating, consistent operating business on the valve side driving for growth; same thing in IPD; and maintaining discipline in the project business in EPD, and really all of our projects, but driving that aftermarket growth.

Great. Thanks a lot.

You are welcome.

Hamzah Mazari, Credit Suisse.

This is Flavio; I am standing in for Hamzah today.

You guys touched a little bit on this on the EPC side and on the Middle East as well. If you could give additional color on your visibility on the larger projects, and maybe anything on timing about enrolling for bookings or any additional color on that.

Well, you know, around the timing -- we have been talking about these project opportunities since 2013. What you see is, with the size and complexity of this, and I think you're hearing this from EPCs -- what people are doing is measuring twice and cutting once before they execute on these. They are going to move forward with them, and I think you have consistently seen that terminology when the awards are going to the EPC firms, but from us, again, they can move quarter to quarter.

What we're talking about from our end is staying focused on growing aftermarket run-rate business, make sure we're very disciplined, because when these cycles come, as you saw back in 2006, 2007 and 2008, they are here for a period of time. What you want to make sure is that when you're in that cycle, you don't have things in your backlog that you felt that you had to take at unfavorable economics. That's the way we're approaching these cycles.

Again, what I made in my initial comments was: If you think about the project business, really with the exception of the Middle East a little bit in 2010 and 2011, it has been fairly soft since the middle of 2008. The fact is, with cycles, is they go down and they go up. We are due for an upswing. You are hearing it from the EPCs. You're probably hearing it from our competition as well.

When it will materialize, on what day or what quarter, can move, especially as these things are very large and complex. But we are confident that they will come. Until that point, we are going to continue to do what we're doing.

That's great to hear. Just a follow-up: If you can give us some detail on how pricing is doing right now, and if you guys have a long-term outlook? I think that the industry is a little more rational right now, post acquisitions, and maybe with the impact of larger projects absorbing some capacities -- just some color on pricing.

I think our comments was -- in the big projects, it certainly remained competitive. This is what you see on the front end of the market. Our competition is very good; it's very capable. They are seeing exactly the same thing.

It's really more looking at our industry. As these projects come in and capacity starts getting allocated to these projects, the next thing that we'll tend to drive is price to a certain degree, and then lead times in the business. But frankly, really, lead times are the last thing that owners want to push out. They want to get these facilities up and running. The longer they take to put together, to assemble and ultimately commission, the more cost attached to it. That is just the way it is.

Price tends to come in first. But if price starts to get a little out of whack, what they will do is start extending lead times.

That makes sense. That's helpful.

As a final question, a little more on the modeling side, what are you guys thinking about assumptions on FX and the impact of the valuation we had last year, which is baked in your guidance range. If that affects the way you're looking at margin markets at all or not?

Our guidance assumes, basically, FX-neutral, from what we said. Depending on where that goes, it could be headwinds or tailwinds, but it's basically based on an FX-neutral basis.

Scott Graham, Jefferies.

I do have two questions for you. The one -- I think it's an easy one. We flushed most of this out last night with your guys, but the backlog being down on a year-over-year basis for five straight quarters, Mark, Tom, the bookings have been kind of sluggish up until the fourth quarter. Is there anything more we should be reading into the backlog decline, or is it more of that last six or seven quarters before this one where things were a little slow?

If you look at our bookings trends, actually they trended down towards the end of 2012, and have trended up over the last four quarters. I think one way to look at our backlog, and our comments around past due and legacy, if you look at our original equipment backlog end of 2012 and into 2013, if you take out the legacy and past due, actually the original equipment backlog would have gone up.

Keep in mind: Past due and legacy backlog typically -- it doesn't have any profit. It doesn't have an economics to it because -- my comment around lead times and everything -- by that time, if it's past due, the economics are usually gone, and actually there's a cost associated with it. If you look at our OE backlog, absent the legacy and past due, it actually went up year over year.

Okay. I had a feeling that that's what it is, and also your focus on higher-quality projects and all of that being kind of dumped down into that same thing.

The next question was really about SG&A. I think it was Mike that mentioned the goal continues to be 18% of sales. How much does the move of the EPD margin -- I'm sorry, the IPD margin to your goal -- how much does that net you in SG&A benefit toward that goal?

If you look at the results over the last couple of years, they have done an excellent job of really controlling those costs and holding them relatively flat. I think, as you look at our SG&A to achieve our objectives, Scott, a lot of the opportunity will be in the EPD side. Because while, typically, the gross margins in large projects, because of the way they're bid and everything, are less than run rate and less than aftermarket. They are large dollar amounts, and you get good fixed-cost leverage on the SG&A line.

I think you saw that a little bit in the third quarter of last year where we had the good leverage on the G&A line in the EPD segment. That's one that is more what I would call just the way financial presentation is. When you get strong top-line growth from projects, even though the margins on big projects are less, you do get fixed-cost leverage on the G&A line. In IPD, what that SG&A has been really on very, very good cost control, which is what you do when you're fixing a platform, is you reassign those costs to their more optimal use, and that is what they have been doing.

On the FCD side, just a solidly run business. So, you want to see SG&A grow, but not as quickly as the top line, because what you're doing is you're adding sales folks; they have been adding aftermarket capabilities. So, that's the way to think of SG&A across all three.

I think you and I had a discussion about this eight years ago. On the corporate line, it's just staying focused that we hold those costs as constant. As you have seen we have really done over the last four or five years. That's your SG&A story.

Okay. It's really not a cost-cut thing, it's more of a maintain it where it is and let the revenue bring it down on a percent basis.

Yes and no. Believe me, there's a lot of activity going on underneath that number where we are adding costs on the R&D side and taking costs out. It's fair to say we are cutting costs in certain areas.

We don't go into them specifically, but we're not in an environment where you saw, back in 2008, where our markets are going away from us, and you don't invest in any future because you don't know when it's necessarily coming, and you just cut costs. I think it's been more -- we have taken some costs out, but we have certainly invested in our R&D platform and other things as well to drive growth.

That's great. I do though have one last question, if you don't mind. When we X out the charge this quarter from cost of sales, it looks to me like your gross margin was up about roughly 100 basis points on a year-over-year basis. I was just wondering -- if you could give us something specific, great. But just sizes of the buckets would be helpful.

How much of that 100 basis points in gross margin was mix versus One Flowserve with Tom Pajonas head manning that? How much of it was operating leverage? What items went the other way? Could you give us some ideas on what those buckets were and their sizes?

Actually mix went against us. You had a shift to more original equipment. I think we talked about this years ago: If you look at the margin differential, 30 bps is probably a good proxy for what a 1% move in mix means, either way, if you just think about the margin differential.

I would say is mostly really attributable to One Flowserve, because what you haven't seen is necessarily big absorption gains that you see -- that we saw in 2008. You saw a lot of price and absorption during that period of time. That comes -- that is also a benefit when you get projects in as you absorb your factories better, but I would attribute it to really the One Flowserve and the efforts around that. And in that is going to be, of course, improving, and improving is the operative word; execution; the quality of the backlog; some of the things we talked about around the discipline; the focus on the run-rate business. So, that's really what has been driving it.

Mike Halloran, Robert Baird.

On the, call it, the run-rate business, obviously a lot of focus has been on when these large projects are coming out. But that run-rate business is a large chunk of your portfolio from an original equipment perspective. Maybe you could try to frame up what the opportunity looks like on a forward basis, just in terms of how much replenishment opportunity is there from underinvestment, and what some of the internal focuses have been that helped drive that business higher over the last couple quarters?

Innomag is a great example. Those are basically seal-less pumps that apply to the chemical industry. Think of them as smaller projects, replacement OE. Even to a certain degree the [MORO], as we call it on the valve side, that when one fails or needs a repair, they just replace it. There has been a lot of focus on that. That is where we really focus, and we have the opportunity to improve our distribution channel. That is one of the things that we are really starting to put some effort in right now, to drive that run-rate business.

As well as, Tom alluded to, one of the things we did last year is put an additional focus and resources and structure around our sales organization to create the right incentives for folks to really go and drive some of those smaller opportunities. If you think about any organizations where there's large projects, history indicates that the sales organization is typically tilted towards the big projects, because that's the larger dollar amounts, that's where you can fill your quotas quicker.

What we have been doing is focused on our channels to market, both internal and external to drive that. But I will go back to some of these things: Execution remains a key, because if you are replacing a piece of equipment, they need it on time. And if they don't, they will go to somebody else. A lot of these things that we have been doing have been trying to drive that business. And I think part of it, around the sales organization that I talked about, is just create a culture that recognizes and rewards that.

It makes sense. On the aftermarket side, obviously healthy growth there. Comps were a little bit easier, but just curious if there's any changing or shifting dynamic there in terms of your ability to go out and capture non-Flowserve aftermarket business, or conversely, if you're seeing any increased competition of folks trying to come in and capture your stuff?

The competition has always been there. We have, as I said, good competitors; they have service capabilities. We maintain still: The best opportunity out there is going to be the customer -- is to do the things like we did in the Dow Benelux a little over a year ago is to go and get those mandates, those opportunities to help them with their uptime.

I think the only trend I talked about in my comments that we saw last year was some sluggishness in North America, which is one of the bigger aftermarket regions.

Makes sense. I appreciate the time, guys.

Nathan Jones, Stifel.

If I could just focus in a little bit on the CapEx side. Your CapEx numbers have been pretty elevated for quite a number of years now, and I understand that's investment in organic growth and there are great returns there. Can you talk about how much further opportunity there is to continue to invest at elevated levels in organic growth?

Yes, Nathan, this is Tom. I would say there's a lot of opportunities on certainly the CapEx applied to R&D, in terms of selling materials and coatings, diagnostics -- we do a lot of efficiency CapEx also in our plants relative to the equipment. We spend a lot of time on making sure that our safety numbers are also world-class. We invest consistently in that particular area.

In addition, we are continuing to add ERP systems as we look at centralizing more of those particular areas, and also business intelligence CapEx in the Business. I would say we still continue to have a lot of opportunities in the CapEx area with that $130 million to $135 million spend that we have been able to maintain over the last couple of years.

Nathan, one of the things to think about, which, with the exception of safety, which we think has an infinite return, we look for a 15-plus internal rate of return on our capital expenditures. Be it a new facility in China and India, which we opened one last year, and we will open one this year; Brazil was in 2012, the QRCs that we have added. We have added hard assets that drive revenue.

When we look at some of the things that Tom talked about in terms of R&D, we're looking to invest in these to drive revenue and growth. We expect a return on them. I think your way of looking at our capital expenditures is the levels we spend in indicate the level of opportunity we think we have to provide that in excess of 15% internal rate of return to our shareholders. Again, save and except safety, because safety is good business.

Nathan, the other thing just to keep in mind is -- we've talked about this a lot. Well north of 50% of that spend rate is really growth related. From that, we have pretty minimal what I would call kind of maintenance capital requirements here at Flowserve. Always think of the large piece of that as growth related.

That's good color. Thanks.

On the past-due backlog, where are you at with that now, and is it possible to quantify what the margin impact was in 2013?

Well, as Tom talked about, we are near -- what good levels will be. There is still opportunity for improvement in the past-due backlog, and I think we talked about levels that were 7%-plus at one point in time, and we were closer to 4% at year end. So, we saw good improvement there. There's still improvement -- opportunity for improvement.

I think the way to think about it is: That's typically business that has little or no gross margin associated with it, and so there is still the SG&A component to it. Specifically, quantifying the margin, I honestly don't have those numbers with me right now, but they do have a margin impact year over year. We saw it from 2012 to -- 2011 to 2012, and then 2012 to 2013.

So, it will obviously be a tailwind for 2014.

Yes, we still have some past due and legacy backlog in 2013, so part of the opportunity in 2014 is we cleared a lot of that last year.

Great. And one quick one for Tom Pajonas. Could you just talk about what activity you're seeing in the pipeline market, specifically outside the US?

I would say certainly the US is probably the most prolific in the pipeline area right now. But good pipeline activity still exists in Russia, as well as in China. So, those are the -- I would say the two primary areas, and to a lesser extent but still there, in Latin America.

Andrew Obin, Bank of America.

Just a question in terms of backlog growth. We have been getting calls from investors concerned about slowdown in oil CapEx, oil and gas CapEx, and the fear is that this is somehow going to be a replay of what we have seen in mining. I was just wondering, how much visibility do you have in terms of your bookings growth throughout 2014?

And just, the second question is: We have been hearing from some oil and gas equipment companies that they do actually expect maybe a pause in orders in 2014. How does it relate to your Business, which I understand is a different business, but still would love to hear what you think about it.

When you look in the oil and gas industry, for us, a lot of what we do is supporting existing capabilities. So, our run-rate and our aftermarket business, which represents about 80% of our Business.

In terms of the new projects that you're seeing out there, you have heard the commentary around the energy market, LNG; chemical is energy as well, in my view, because of the feed stock is going to be natural gas, which leads to the pipelines and other production capabilities around that. And also around the world. When you go and look at areas around the world -- and there was some commentary even Tom made -- some of the infrastructure needs to be upgraded and repaired. They are still adding some capacity in different parts of the world -- low natural gas and oil production in the United States.

So, it depends on what the oil equipment is, but ours is -- if you think about flow control, it's really basic to a process. Some equipment may be a marginal enhancement around the process or a specific complex application which could be marginalized for a short period of time. But when you look at ours, ours is very basic to -- core to the process itself. So, when we see these facilities come on or the pipelines being built, we know that's going to create demand for our product down the road.

Just to add a few specifics on the back of Mark's comments. There's a lot of activity in LNG in the US and Canada. There's been five projects in Canada alone, four in the US that have been granted licenses out of about 20 proposed export terminals. That looks pretty good. This whole area about LNG and transportation business could create opportunities for natural gas in North America.

European refineries are going through some changes right now on that side of the Business, but as the other question came up on the pipeline, the pipeline growth is pretty good in the US, Russia, as well as China still. We are still seeing good Middle East oil and gas, Brazil offshore oil and gas, and Russia oil and gas business in general. We have projects out there in the oil and gas side. You heard some of the EPC comments from some of the other investor calls; they got good order growth on the oil and gas side also.

Just a question just to follow up on -- in terms of M&A, you have been more rational than some of your competitors in terms of what you guys are willing to pay. Do you feel you are at a disadvantage with your more disciplined approach, and just a little bit more color on the M&A market just given how excited people are about flow these days.

We are disciplined. I wouldn't necessarily say more rational. Think about some of the other transactions that have occurred. They have gone into financial sponsors' hands, and the financial sponsors had the opportunity to use leverage and to drive returns. For them, that's very rational.

Some of the strategic moves over the last couple of years have been some assets that have traded hands because they needed that product base, that platform. It had strategic value, which encouraged them to pay a higher price. I certainly can't argue with that.

When we look at M&A opportunities, one thing to keep in mind is: We have a very broad product portfolio set. What we're looking to do is fill in between those opportunities. That will also dictate ultimately the price that we pay for it. But, for any company, if it's strategic, and you can create the type of returns that make sense for your shareholders, then you will pay that appropriate price for that. For those that are really looking to focus and get into the flow control industry, to them that makes sense.

You feel you can operate pretty well in this environment, and still be able to source quality deals?

Yes. We definitely do.

Thank you very much.

Steve Fisher, UBS

As you guys think about 2014, which of your initiatives do you expect to produce the most incremental improvement, be it on-time delivery, cost of quality, low-cost sourcing? It sounds like past-due backlog has already had the biggest incremental impact, or a big one, so what about the rest of them?

Well, there's a lot of ones that have ongoing benefits. I think the improving execution that you are seeing, we still don't have all of our facilities to where they need to be. Some of them have quite a bit of work to do. That not only provides opportunities in terms of efficiency or margin improvement in that facility, but also you will find customers willing to give more work when they can execute well.

The other thing is, depending on market dynamics, we may pull different levers. So, I don't want to just say this is what is set in stone right now to what we are going to do, and we're not going to change course.

But going back to -- and I hate to give you a broad answer, but it is really the way we think about these things. Our suite of One Flowserve initiatives that we put in place, that type of environment, that type of culture takes, really, years to build into a business. We are only two years into it. And we're starting some other initiatives as well. What I would say, looking broadly, is I think the focus on the four walls was a big contributor last year, and it is certainly going to be a big contributor this year.

Okay. And then -- it doesn't sound like your approach to [some] activity changes in 2014 versus what it was in 2013, but to what extent do you expect the need to be selective change -- the change in 2014?

My comments earlier is: You are always, hopefully, selected. It's just what are you choosing against. And my remarks earlier around 2010 -- your selectivity was focused on absorption, because a large engineered facility that isn't absorbed can get very, very expensive. So, your selectivity and your variables that you look at around do change over a period of time.

As you move into where you see market opportunities coming for a period of time -- and remember, the projects -- I will just go back and you don't have the benefit of history, but some of the projects we took in 2006, 2007, 2008, lasted in our business in some form or fashion all the way almost to 2011. When we are selective, we need to think multi-years in terms of how this thing is going to play out.

But I think now where we are, what we talk about is making sure that we are maintaining or improving our backlog, that we are where we need to be, and that is be aggressive where we see a good long-term aftermarket opportunity, where we can take advantage of our LPO/ SPO strategy, where we have a good relationship, broad relationship with a customer across our three platforms, and we want to make sure we really leverage it. Those are going to be the variables that come in around selectivity.

Okay, great. Thank you.

Brian Konigsberg, Vertical Research.

I just want to actually come back to -- I think it was the question that Andrew asked about -- concern about oil and gas CapEx, and how it might relate to pricing. You discussed some of the large projects -- were very competitive at the very start, which is not very surprising. But how much do you think that is coming from project owners just being a lot more concerned about what they're paying for equipment and spending on their projects, wanting to get the most bang for their buck just given that there are more constraints on CapEx than there had been before?

I think that's the issue we talked about. It's not just a concern in general, it's the size and complexity of these projects. They want to make sure -- you used the term, get the most bang for their buck. Keep in mind: At times, that's lowest cost. Particularly you see a lot of that in the Middle East. But in other parts of the world, that's around efficiency, making sure the process conditions are right, making sure you have the right support long term.

What I want to suggest is they are certainly competitive, but they want to make sure that you can deliver a quality product on time because, in the world, you may pay less for a piece of equipment, but if it doesn't work it is worthless to you. I think you are absolutely right, is, what they're seeing is the size and complexity of these projects, and they're just being very thoughtful. They need them, they need the infrastructure, but they are just being very thoughtful, and that is what tends, in these cycles, to push things out.

What you saw -- the reason it ran up so quickly so fast back in 2007 and 2008 is you all of a sudden saw all of the material costs and all of these commodity costs spike so quickly. What was happening during that period of time is these folks would budget these projects at x, and the next time they went through a budget effort, not too long afterwards, it was 1.5x, 2x. So, they had to rush to market, because they were concerned that 2x could go to 4x. You saw that with the commodity boom at that point in time.

This one -- what you're seeing is the commodities are elevated; certainly oil is. Commodity is justifying spend in infrastructure, but they can certainly be very thoughtful. That's not a bad thing for our industry. Because when you see a spike up like you saw a number of years ago, they start splitting orders, they start extending lead times; that is how the market responds.

We see a fairly orderly move is -- for everybody, we all wish it would have been sooner, we certainly do, but we also understand why these things take time. Meanwhile, as we have made in our comments, what we are going to do is continue to focus on what we can, the four walls, driving the run rate, driving the aftermarket business, which has really been the primary contributor to our earnings.

Fair enough. Just on the projects that actually have been [led] from the EPC perspective, obviously they're fairly large, and I think you could argue on average they are larger than what we saw last cycle. How quickly do you think that will absorb industry capacity among your peers, and start to make it a more attractive bid process for you to get involved?

That's a good point. It depends on the pace at which they come and the lead time. I think what you will see is they're going to try to keep the lead time short, so that the project costs don't increase. I think as these projects start to roll, and we have seen some. They have certainly been competitive more recently, but it doesn't take too long for the industry to try to allocate the capacity.

Having said that, we have added capacity in certain regions of the world; a lot of that to address the opportunities there. But still, that represents capacity under our LPO/SPO we can use around the world. I think it's a little bit of -- it's a broader market than it was six, seven years ago, because your buyers are now stronger in China and other parts of the world. And so it's a broader base that's going to drive the spend.

But I think as you see this, what's going to happen is they're going to try to keep their lead times down, and that will start utilizing our industry's capacity. It really depends on the pace at which they come on.

I would add to that -- you basically are going to look at three areas, as Mark has already alluded to. You always look at the engineering area, you look at the supply base, and you look at the construction piece. Depending on regionally how things are concentrated, you could have overcapacity in any one of those, or undercapacity. It will depend, but those are the generally three areas that are indicators for you.

If I could sneak one last in, just for Mike. Just on the working capital initiatives, with the large cycle in front of us, obviously that would typically require working capital build, not a reduction. How difficult is it going to be to achieve your targets over the next couple of years given the cycle is really only just starting?

Brian, a lot of that just depends on how well we do on the front end. Part of this whole front-end project, when we talk about our selectivity and discipline, not only is it -- as it relates to the margin in the projects, it also relates to the terms and conditions. And part of those terms and conditions are the cash flows associated with those projects.

It's on us to do a good job of negotiating those payment terms upfront, to make sure that for these large projects that require advanced procurement, that we say, at worst case, even cash flow. That's something Tom's group and the legal group have done a great job on -- on putting some new initiatives in place as we look at these projects. And also, working with the finance and operations and legal, we will work hard to make sure we try to get terms that are agreeable to both us and the customer.

To further that, just to be clear, our goal is to have an improved working capital efficiency platform versus the last cycle. But to your point, when the cycle builds, depending on how quickly does, it tends to tap your balance sheet. When the cycle turns down, as you saw in 2009, it will tend to liquidate. And you saw that in the last cycle, but I think what we want to make sure is clear is we want to have a more disciplined, efficient process relative to the last cycle.

Fair enough. Thank you.

Chase Jacobson, William Blair.

Can you just remind us, on these big chemical projects, what the lead times are? What the normal lead times are, and how long it takes from the time of award until we start seeing the revenue hit the income statement?

If you take a look at -- let's say some very large projects, and we define it that way, from when an EPC gets an award to when Flowserve gets the PO could be anywhere from six months to one year. And then, on these very large projects -- if you look at a pump, it could be 18 to 24 months between PO and shipment.

Keep in mind also that depending on the job, you're also maybe doing percentage of completion accounting, so that you are taking revenues and operating income through those projects if it's percentage of completion. That then varies depending on whether you go to medium, then those things come down by 30%, 40% on the medium projects. That's the order of range that we're talking about here on the very large projects.

Okay, that's helpful. Based on that, and looking at some of these ethylene projects and when they are expected to start up, I know you guys have been talking about having visibility into them for a while, but it seems like they should be coming pretty soon. You also talked about competition. Are you aware of any of these that have already been let to any of your competitors, or are they still all out there as a Flowserve opportunity?

Just give you some specifics, in Q4 alone, there has been several ethylene projects that have been announced, one in Baytown, Texas, one in Louisiana, one in Ingleside, Texas, and another one in Point Comfort, Texas. We're starting to see these ethylene projects in the US come pretty good.

And again, you are beginning to see other areas on the oil and gas side worldwide. Some of the big EPCs have announced projects now in Kuwait and Oman. You have some D-cell areas -- I know it's not chemical in your question, but again, we're starting to see some of those announcements come out. And then you can add onto that the time frame that we just gave you on the large projects for when we potentially, if we are successful in winning the bid, could see those projects.

So, they do take a while to come to us. What you typically see are some of the longer lead items that go out first -- that get bid first. For us, the pumps are in the middle of the way, and then the valves come afterwards.

Your other question is: We have, we do, and we will continue to always have competition out there that will be bidding on these projects as well.

We have now reached our allotted time, and I will now turn the call back to Jay Roueche for final comments.

Again, we thank you all for participating in today's call and for your interest in Flowserve. We look forward to seeing many of you at upcoming investor events, including our analyst day.

If you have any follow-up questions or were left in the queue, please call Mike Mullin or me. With that, operator, we have concluded today's call.

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