福斯 (FLS) 2014 Q1 法說會逐字稿

Welcome to the Flowserve first-quarter 2014 earnings conference call. My name is Ellen, and I will be your operator for today's call. (Operator Instructions). I will now turn the call over to Jay Roueche. Mr. Roueche, you may begin.

Thank you, Operator, and good morning, everyone. We appreciate you participating in our call today to discuss Flowserve Corporation's financial results for the first quarter of 2014, which we published yesterday afternoon 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 flowserve.com in the investor relations section. An audio replay will also be available on our website approximately two hours following the conclusion of this 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 this call and the associated earnings materials contain forward-looking statements that are based upon forecasts, expectations, and other information available to management as of April 23, 2014. These statements involve numerous risks and uncertainties, including many that are beyond the Company's control. Therefore, we encourage you to fully review our Safe Harbor disclosures contained in yesterday's press release, slide presentation, and in our filings with the Securities and Exchange Commission, including our Form 10-Q filing for the period ending March 31, 2014. All of these documents are accessible on our website under 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.

I am pleased with our operating and financial performance in the first quarter. We met our expectations for the three-month period, which provides confidence in our 2014 guidance. I appreciate the commitment and dedication of our employees. They have continued to embrace our performance culture initiatives, while increasing their focus on exceeding our customers' requirements.

These efforts, evidenced by our notable operational improvements, enhanced Flowserve's ability to capture the expected growth provided by accelerating market demands and aftermarket opportunities. EPS of $0.78 increased over 16% versus last year's first quarter. While Mike will discuss the details of our financials in a moment, I would simply add that our core business delivered and is demonstrating the improvements in our operating platform necessary to support anticipated revenue growth.

Bookings of $1.2 billion increased slightly over last year, driven by strong aftermarket growth of over 8%. Aftermarket bookings of $517 million were at a record level for the period and highlight the success of our ongoing commitment to end-user strategies and supporting our customers.

Our original equipment bookings were again driven by the recurring short-cycle run-rate business, which continues to provide a solid foundation of profitable work. Although we bid on a few larger projects during the quarter, these initial opportunities were competitive, as expected. We remain disciplined and selective and continue to believe our shareholders will be rewarded by this approach over the cycle. With the anticipated ramp-up of energy-related projects, particularly in the Gulf Coast, we believe there is ample opportunity for near-term bookings and revenue growth on the horizon.

Additionally, I would like to highlight the IPD segment. Over the past few years, it has delivered on its commitment to improve the operating platform and is now shifting focus towards higher growth. As evidence of this progress, IPD's bookings grew over 10% year over year, demonstrating its operational progress and customers' increasing confidence in its capabilities.

These solid bookings produced a quarter-end backlog of $2.7 billion, level with a year ago, but significantly improved in terms of quality and past-due levels. Compared to year-end, backlog is up over $130 million, or 5.2%.

Despite traditional seasonality, Flowserve again demonstrated the strong leverage that exists in the business, driven primarily by improving execution, as well as focused cost control and modest aftermarket mix shift. Gross margins improved across all segments, including an impressive 280 basis-point increase in FCD.

Last month, we dedicated significant time during our analyst day highlighting the operational improvements that we have implemented over the last few years. This quarter's strong gross and operating margins are a direct result of these initiatives. However, I want to emphasize again that significant propensity remains to further enhance our business, and even as we prioritize increased growth, we will continue to focus on the customer and improving key metrics.

Turning to our end markets, several project owners have made final investment decisions on large infrastructure investments over the last few quarters, which is encouraging. A number of these energy-related projects have already been awarded to E&Cs, and we are currently bidding on many of them. Our visibility into the progression of similar projects as they move towards final investment decision provides us additional confidence in an improving cycle.

By region, North America shale production continues to support investment in chemical and oil and gas projects. Ongoing efficiency investments in Europe's infrastructure drove modest growth over the last year. We continue to pursue opportunities in Asia-Pacific and aim to further increase our presence and market penetration in that region to support growth.

Middle East investment is expected to continue, as they look to capture more of the value in downstream products, although it remains the most competitive market. And while political and financial instability in Latin America pose some challenges, their efforts to increase production should provide opportunities over the coming years, assuming these issues could be managed.

In addition to expected near-term organic growth in our core end markets, we also continue to target technology, product, and geographic additions through strategic bolt-on acquisitions. Our disciplined approach towards these opportunities requires rates of return that add value for our shareholders.

Likewise, we take the same disciplined approach when evaluating our existing portfolio. If an asset is not performing to the level we expect, serving a key market, or providing the appropriate growth opportunities, we will either take the necessary actions to correct it or divest the business if another party values it more highly.

Our recent divestiture of Naval, a non-core district heating valve asset, is a good example of this approach in action, as we regularly evaluate our assets based on rates of return and strategic fit to drive value for our shareholders.

As we look forward to the remainder of 2014, I am confident that our actions over the last few years have significantly improved our operations and ability to support customers' requirements. As a result, Flowserve is now well positioned to take advantage of the growing energy markets we see ahead.

So with that overview, I will turn the call over to Tom.

Thanks, Mark, and good morning, everyone.

Our first-quarter results have us well positioned to deliver on our full-year 2014 targets. As we have discussed in detail of late, there remains substantial opportunity within the business and we continue to focus on improving our operations.

Our goal is to better align our processes with our customers' expectations as we prepare for the improving growth expected in our key energy markets. These customer-focused initiatives include continued localization, strategic initiatives to drive enhanced customer focus, raising the bar on our performance culture, and building the project management expertise to complement our strong product manufacturing culture and processes. All of these efforts should enhance our flexibility and enable Flowserve to adjust to the changes in our markets and customer requirements.

The first-quarter results again demonstrated the progress we have driven within the four walls of Flowserve. Despite lower revenues, we increased gross margins and delivered solid flowthrough. Our improving execution and operational metrics, combined with disciplined cost control and leverage, resulted in a strong gross margin performance in each segment. In particular, FCD's notable 280 basis-point improvement was impressive and included a favorable mix of product shipments to the power and oil and gas markets.

IPD continued its steady operating improvement and is achieving progress towards its targeted 14% to 15% operating margin goal by the end of next year. The improvement in this segment has increased our ability to meet customer expectations and their lead times, which drove a strong 15% increase in their original equipment bookings and prepares it for expected accelerated growth.

EPD delivered a 6.3% bookings increase on a constant-currency basis, driven by strong aftermarket bookings from increased activity in the Gulf Coast and Europe.

As many of you know, this segment has the greatest exposure to the larger project activity that we anticipate to build as the year progresses. As we have discussed previously, these initial larger projects are competitive in both price and terms, and we have experienced these conditions on recent Middle East projects.

However, we maintain and will continue to pursue our disciplined approach. We will focus the customer on the benefits of our key differentiators, including our technical capabilities, on-time delivery performance, the total cost of ownership, and our localized presence. This approach will continue to support the quality of our backlog.

Summarizing our end markets, oil and gas remains solid, considering current oil prices and the positive long-term outlook. These factors support major investments. We expect new refining investments in the Middle East, Asia, and Latin America, but somewhat at the expense of European refining capacity. North America continues its strong growth in pipeline construction, refinery upgrades, gas processing, oil sands development, and gas-to-liquid plants that capitalize on advantaged natural gas and oil supplies.

Additionally, continued opportunities exist in liquefied natural gas facilities, particularly in the US. Longer term, opportunities in Mexico should increase, following the recent policy reform intended to increase production levels.

From an aftermarket standpoint, maintenance activity has increased in the Gulf Coast and Europe, as expected, from the lower levels we have faced since the second half of 2012. We're also beginning to see aftermarket benefits from the Yanbu project booked several years ago in a very competitive market.

The chemical market also remains strong and the outlook is very positive, as new capacity investments in North America continue to advance. The first quarter included equipment awards for the first ethylene project in the Gulf Coast. Announced North American shale gas related investments are impressive, valued at over $70 billion, and the majority of this capacity is destined for ethylene and ethylene derivative projects, considering the US has now joined the Middle East as a low-cost feedstock leader.

In the Middle East, their efforts towards downstream diversification continue, while Asia and Latin America reassess their chemical development plans, based on competing opportunities in the US.

Moving to the power market, we expect growth. China, India, and Russia continue to pursue fossil-based projects. The Middle East also sees growth, both in conventional and solar power. North America and Europe, however, remain slower, due largely to conservation, the lack of a consistent energy policy, and modest energy demand drivers. However, the low price of natural gas should drive the US combined cycle market.

Nuclear power remains in transition, but we see continued development in China, Russia, and South Korea and discussions of new capacity in some regions of Europe. Japan is even considering restarting up to one-third of its idled capacity.

Finally, natural gas combined cycle plants are a global opportunity, although US expansion could be impacted somewhat by pipeline constraints.

Our general industries markets faced challenges in the first quarter as mining companies cautiously evaluated projects based on concerns of oversupply. Global fertilizer projects remained on track, and our distribution business, primarily valves, continued to produce solid levels in the first quarter, driven by the oil and gas markets.

Wrapping up, we have delivered significant progress in our operating profile, and while we will continue to drive further operational improvements, our focus is on growth and building on a culture of performance that consistently delivers results. However, I'm also confident that the propensity remains for ongoing operational improvement. Improving our flexibility, pulling various operating and growth levers, and increasing our ability to react quickly to opportunities across our broad product, geographic, and industry exposure will continue to position Flowserve as a value-added supplier of choice.

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

Thank you, Tom, and good morning, everyone.

With our operational overview and business outlook well covered, let me discussed in greater detail our financial results for the quarter. We began 2014 with a strong operational performance and are well positioned to deliver on our guidance for the year.

First-quarter EPS increased 16.4% to $0.78. Included in EPS is $0.03 per share of net benefits. As we discussed in the press release, this amount is comprised of a $0.05 gain on the sale of our Naval district heating valve business, partially offset by a combined $0.02 of realignment charges and below-the-line currency expense. Excluding these items and the $0.03 per share net benefit from discrete items in 2013, EPS increased 17.2% year over year.

As expected, the first quarter reflected typical seasonality, with revenues down 2.6%, or 1.3% on a constant-currency basis. Even so, we delivered improved gross margins across each segment through strong execution, a higher quality of revenue, continued emphasis on low-cost sourcing, and a 1% mix shift towards aftermarket.

Turning to SG&A, our results demonstrated focused cost control. As reported, SG&A as a percentage of sales was down 120 basis points. Two items skewed our results, including the $12.6 million net gain on the sale of a business in 2014 and $1.7 million of joint venture transaction fees in 2013. Adjusting for these items, SG&A expense declined $4 million year over year. As we have indicated, our longer-term goal is to achieve full-year recurring SG&A as a percentage of sales to be consistently in the 18% range.

We have made substantial progress over the last few years, and opportunities clearly remain. Progress will ebb and flow quarter to quarter, since even as we lower costs in some areas, we are also making strategic investments in others to improve our platform. For instance, over the last year or so, we have invested in quality and project management programs in personnel, increased research and development spend, and reorganized our global sales organization.

To be sure, our end goal is not only focused on dollars spent, but also increasing our capabilities, efficiency, and productivity. We will continue to further optimize SG&A in this manner over the next few years.

On a reported basis, operating margins were down 10 basis points to 15.4%. However, excluding the discrete items we previously discussed, operating margins increased 120 basis points year over year to 14.3%.

Below the line, foreign currency had a negative impact of approximately $2 million in the 2014 quarter, but it decreased significantly from last year's $11 million negative impact, which included $4 million of Venezuela devaluation. While we continue to monitor this year's developments in Venezuela, we have not recorded a charge for any further devaluation.

Our tax rate in 2014 first quarter was 26% and was lower than our previous expectations, due to certain beneficial tax items. For the remaining quarters of 2014, we continue to expect a tax rate of nearly 30%.

Turning to cash flows, as many of you know, the first quarter seasonally tends to be a major usage of cash, and it was again in 2014. We used about $85 million in our operations during the quarter, but that was an improvement of $23 million versus last year. We also spent another $171 million, combined, for share repurchases, dividends, capital expenditures, and debt payments, while the sale of the Naval business generated cash inflow of approximately $47 million.

In the end, we finished the quarter with no borrowings on our corporate revolver and about $165 million in cash. Similar to the seasonality of our earnings profile, we also expect the first quarter to be the trough for cash flow and anticipate much stronger performance during the remainder of the year.

Focus on cash flows and working capital will remain a priority as we work towards our goal of consistently generating annual free cash flow near our net income level. We continue to execute on our strategy to efficiently deploy the balance sheet and return value to shareholders. At quarter-end, we had about $275 million remaining under our authorized buyback program.

Turning to working capital, it's a mixed story. Although DSOs increased three days and inventory turns were flat compared to a year ago, the combined dollar balance of receivables and inventory was down around $27 million from 2013 levels, and these items were cash neutral in the 2014 quarter, which is an improvement of $43 million versus a year ago.

I remain confident that the working capital initiatives previously detailed will drive improvement in our metrics over the next few years, as we continue to target DSO in the mid-60s and inventory turns of 4 to 4.5 times.

Moving to our EPS guidance and outlook for the remainder of the year, we are reaffirming our 2014 earnings guidance of $3.65 to $4 per share. We also continue to expect revenue growth of 3% to 6% on a neutral FX basis.

Turning to our spending priorities, after a couple of years of accelerated returns to shareholders to optimize our balance sheet, we expect to return to our stated policy of returning 40% to 50% of our running two-year average net earnings to shareholders through dividends and share repurchases.

Importantly, we fully intend to invest in our business for profitable growth and solid organic returns. Capital expenditures were $31.7 million in the first quarter, and we continue to expect full-year CapEx in the $130 million to $140 million range. These investments include adding and expanding capacity in regions like India and China, introducing new products, and, as many of you saw in Raleigh, replacing and upgrading manufacturing equipment.

We believe this new approach of capital returns to shareholders, with organic and acquisitive investment in our business, will provide Flowserve shareholders solid returns over time.

Other uses of cash we expect for the remainder of the year include pension contributions and scheduled debt repayments, but even combined, this amount is modest in comparison to the other priorities.

Lastly, I'd like to thank the many of you who attended our analyst day in Raleigh last month. For those of you who were unable to participate and have an interest, the presentation is available on our website.

In the weeks ahead, we are planning a fairly active investor relations schedule, with investor meetings in Europe, scheduled visits to our offices here, and a number of conferences over the next few months. We value our time with the financial community and our shareholders and anticipate there will be several venues available to you ahead.

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

Thank you, Mike. Operator, we have concluded this morning's prepared remarks and would now like to open the call up to any questions.

(Operator Instructions). Hamzah Mazari, Credit Suisse.

The first question is just on maybe if you could give a little more color as to how you plan to balance getting some of these larger projects that are coming in pretty competitive, as well as balancing taking a lower-margin project and getting the aftermarket for it. You mentioned Yanbu was pretty low margin, but now you are seeing the aftermarket for that.

Do you expect the competitive environment to get better and margins to get less competitive as some of these larger projects come online? Maybe just walk us through what your thought process there is and how selective you're going to be.

Just your question indicates really how we think about it and the complexity. You are exactly right.

The way we look -- first, to the first question, what happens in our industry is as capacity starts to fill up, then the industry starts to use lead times to the extent they can, but there is reluctance to do that because time is money on these projects for the engineering contracting firms, but then the industry also starts to use price to rationalize capacity. So that's a general theme in our industry.

When we talked to you back in 2010, you had a number of forces that were really driving a very price competitive market -- Middle East projects, Korean contractors, and the like at that point in time. Setting that aside, what we do, though, is we look at our capacity long term and capacity utilization in terms of potential absorption. That's a factor you consider relative to where you see in the market cycle, but you also look strategically at some of these projects. So if you've got a good foothold on the aftermarket, you want to make sure you are very competitive.

Having said that, I can tell you in our industry a bad project never gets better and so one of the things that we are always very careful with, because we had discussions with you for a couple of years about past-due backlog and legacy backlog. That is not a situation that gets better and we think really provides the types of returns for our shareholders.

So we will balance all of that, and in the meantime, what we want to do is continue to focus on execution because that allows us to be more competitive. So as we look at these projects, we will look over -- at our capacity over a year and a half to two years; anticipate how it is going to get utilized; look at market expectations around the world, because with our LPO/SPO, we can move work all around the world; and look at the aftermarket opportunities; look at other pullthrough of products because, keep in mind, it's not just a certain type of pump that we are selling. There are seals that go with it and there is valve opportunities as well, and that's how we will consider the projects.

But at this phase, and we talked about this in the first quarter, we saw some that were just very, very competitive. And yes, we could have taken a couple of those and those may have changed the comps that we are talking about today, and while that would change the discussion or the perception of the discussion, it really doesn't change the discussion because if those aren't profitable, they may go into our backlog, but they're not going to deliver value to our shareholders.

So, it is a very thoughtful and complex way we do that, but it's important to know the process we use around One Flowserve really looks across all of our global capacity, all of our capabilities, our supply-chain capabilities, aftermarket and pullthrough opportunities, the other products that we can bundle in, and that's how we consider how we want to take a project. What we don't want to do is fill up our capacity with projects that don't meet our economic requirements.

That's very helpful.

Long answer to your question, but I think that's important, because just the length of this answer indicates the level of detail and thought we go through when we look at a project.

I appreciate the answer. It's very helpful.

On the aftermarket side, how much of that growth is just pent-up demand or deferred maintenance, relative to just underlying growth that you are seeing within that business right now? Is there a way to parse that out or think about that?

On a percentage basis, no, but on an anecdotal basis, you heard Tom's comment around what we have seen in the Gulf Coast region with increased maintenance spend. Over the last couple of years, European production process facilities have been holding back on maintenance CapEx. So some of that is starting to come back online. That certainly contributed.

Also, as we talked about, some of the installed base that we put in over the last couple years is bearing fruit. And then, there is an aspect of it where we are really executing our end-user strategies. So, if we have talked about 8%-plus growth in aftermarket, really look at the growth over the last couple of years. There is not that much incremental net installed base that goes in around the world at that point in time.

So what that indicates is we are gaining ground executing on our strategies, but there certainly will be cycles. Now what you are seeing with the opportunities in the Gulf Coast region is they're going to start putting money back into maintenance.

Charley Brady, BMO Capital Markets.

This is Patrick (multiple speakers). This is Patrick actually dialing in for Charley. On the booking side, I just was wondering what was the tenor of that during the quarter.

Hold on, can you speak up? I can't hear you.

Sorry, sorry. By the way, this is Patrick dialing for (multiple speakers).

Hi, Patrick, okay.

On the bookings side, what was the tenor of that during the quarter? Was there a steady uptick?

And I guess, also, if you could give a little bit more color on the backlog as well. How are the margins now, say, versus two or three years ago? Has there been (multiple speakers) increased bookings?

One of the things, typically we don't really talk about current quarter information, but in the press release and our commentary, we talked about accelerating in some of the activity in April.

Now three months -- three weeks in a quarter doesn't necessarily make the quarter, but we wanted to give the market an indication of what we have seen, and I think some of our competitors in our industry have seen, is that towards the end of the first quarter, things started to pick up, again competitive on some of the large projects, and that's continued into April as well.

As for the comments on the backlog, if you think about it, especially on the large projects, backlog can be around a while. And we embarked on this journey a little over two years ago around being disciplined and focusing on execution and all the processes associated with it. What that means and has meant is that our backlog has continued to improve over time.

So as we look at this year's backlog, and you heard it my comments over last year's, you have seen growth in our aftermarket business, but more importantly, we are not having discussions really now around significant legacy or past-due backlog, and that type of backlog tends to have little or no margin at the gross margin level.

So, that can just highlight to you that we've seen good improvement in our backlog, and we think that's important because not only does it impact margins, it impacts working capital, it impacts our customers, it impacts our sites. It flows through the entire system. We do still have work to do, and one of the outcomes over time of this continued discipline and execution will be more efficiency in our working capital.

Got it. Can you guys -- moving on to the segments, can you guys provide a little bit more color on how much the key end markets are up or down, relative across the three segments?

You're going to have to speak up again; you kind of drifted on us.

Can you provide a little bit more color on how much the key end markets -- oil, gas, chemical, and power gen -- were up or down relative across the three segments?

I think -- well, we need to look at trends over a couple of quarters because, for example, the decline in bookings was more focused on our FCD business, a very high-performing business. We saw a pretty good level of oil and gas orders last year on some FPSO opportunities.

So when you look any quarter year over year compare, you got to be very careful about calling a trend, but that's a good business. It does well. As we have indicated oftentimes in the first quarter, don't read that as the year for that division. It's executing at a very, very high level. But sometimes, you will have some challenging comps.

Generally in our industries, we have heard there has been talk certainly around the E&P side in oil and gas, but keep in mind where we participate. It's more on the processing side. And what that means is when you take a hydrocarbon, when you take any kind of feedstock and you can process it in a different manner or transport it, which you are seeing increasing levels of, that benefits our industry.

Another comment on the power side where you see improvement is we have been in gridlock certainly in the United States around fossil-based power plants, but they have gone to combined cycle. We have seen what has happened to the nuclear industry and some signs of life. As we had indicated years ago, that represents 20% of the global supply of power. There is no way to diversify away from that over a short period of time, and you look at all the aspects of what's going on around the world in energy security, and it's difficult for countries even like Germany that said they were going to exit it to completely exit it now because they are reliant on natural gas from Russia.

So, I think it's important to consider there can be positives in certain areas of the power industry, but as long as people move to urban areas and there is population growth, there is going to be demand for more power. (multiple speakers). Go ahead, next question.

Jamie Sullivan, RBC Capital Markets.

Mark, a question on the run rate of OE business and the opportunities there. Maybe you can just give us your view on that cycle and maybe what the growth of that market opportunity is, assuming that these large projects are going to be lumpy and sometimes competitive, as you mentioned.

Some of those large projects will pull through some of what we -- more of our run rate products. If you look at EPD and IPD, IPD will tend to benefit from project opportunities because they will supply some more of the configured order.

I think in general when you see upgrades and retrofits of large and medium-sized facilities, and as Tom commented, when you see the distribution channel start to take in more inventory during those periods of time, and more important, Flowserve specific as IPD continues to improve its execution, that gives us encouragement in that run rate business.

I think other areas, as we talked about -- in Mike's comments, he talked about our sales force. We're making a lot of changes here at the Company, but one of them is if you think about it, companies tend to like to hunt elephants. Bringing focus in comp plans around driving this run rate business is important, as well.

So I think there is market-driven aspects to it. There is a benefit from project activity. There is a benefit to aftermarket from project activity because there is -- I talked about these before -- commission spares that go with a new project. So that is the macro outside-in looking opportunity for that business.

I think improving the way we execute into our distribution channel. FCD does it quite well. We have got room for improvement in IPD, as well. Focusing our sales organization, improving execution will give us the opportunity to continue to drive that -- more of that configured-order, smaller run rate business.

Okay, thanks. That's helpful. And then, maybe, you talked about IPD, the bookings up 10% or so. I know they had a little bit of an easy comp, but you talked about the focus on growth and some success there. Can you maybe give us some more details on that, maybe how resources are allocated or focused now, or initiatives that we don't see outside of the numbers that is making you feel good about the progress there?

The way it's operating, it gave us more confidence in executing on our acquisition of Innomag last year. If you think about it, the one thing you don't want to do is acquire an asset, a business, for a company that isn't performing at the level it should, because it doesn't make things better.

So, I think that's one great indication of the way that we are thinking about the business is to bring in more products for them to deliver to our customers.

Another thing that we've talked about is just aligning the sales organization and making the investments that we have. That's one of the businesses where we have made investments on the chemical side to support the ISO standard chemical equipment, so it's going to be investment in terms of R&D, sales organization, people talent, inorganic investment opportunities as well, because oftentimes on some of these bolt-ons, those are the type of products that are configured to order that we can bring in and load onto our platform.

Honestly, a highly engineered, long-cycle piece of equipment, we can tend to develop ourselves, and when you go out and make those type of acquisitions, you're typically just buying installed base and setting yourself up for an opportunity to consolidate manufacturing capacity.

And I would add to that if you look at the IPD business, bookings were up in many different areas, so not just one, so chemical was up, [and GI], water, oil and gas. The only one that was down a little bit was the power business, which was expected. Both the aftermarket and the OE business were up.

If you look at the regions, again, it was broad-brush, up across all the regions, with the exception of the Middle East. So there was a good strength across a wide berth of both region and industries on the IPD side and, as Mark has indicated, just good solid execution on the orders that they were getting in.

William Bremer, Maxim Group.

We know Flowserve's expertise on the downstream market. Can you provide us an update on what you have seen and some of the initiatives that you are doing on upstream?

We made a couple of comments around our participating in the [bresshures] for offshore platforms and also FPSOs, as well. We also provide some of the fire water pump for some of the offshore platforms.

If you think about type of rotating equipment opportunities and valve opportunities, that's really where we participate on the upstream side. However, there are things we do near upstream that I would call, again, like in the tar sands where you're right there proximate to the production facility and there is a preprocessing activity that occurs so that the product is easier to transport, as opposed to hauling in large trucks and containers. So at the wellhead, there are certainly some downwater injection pumps and things like that to where we can participate, but it's really going to be around flow control. That's our core competency.

And then on the midstream as well, and Bill, I know you're fairly familiar with that. You have valves. The valve -- our valve is critical on some of the gas pipelines. Certainly, whether it is gas or liquid -- if it is a liquid pipeline, you've got pumps that go on it, seals as well. And then, if you think about upstream and midstream, that means that product is going somewhere to get processed.

Okay, great. My second question, and I appreciate the color there, you called out nuclear a little bit. Can you give us a little color on what is happening on the waterfront, a little desalinization there? I know it's a very small piece, but what are you seeing in terms of some of the projects?

Yes, the -- you want me to cover nuclear or you want me to cover the water piece itself?

They sort of go hand in hand.

Okay, yes, in the Middle East, you are right. I would say the power business and the desal business kind of go hand in hand, because they try to put those two things together. We are seeing a pickup in the desal business, particularly in the Middle East, China, and I would also add India into that.

We are seeing some -- a fair amount of activity in the water business itself, not necessarily desal, but water being a simple business in the US out of our industrial group. So as the financial condition changes with some of the cities in the US, they seem to be moving on some of those projects.

We're also seeing some Latin American countries look at desal, as certain countries have mandatory requirements to use desal for mining in order to conserve some of the water supply because they are having some shortages in Latin America. So we are seeing some good projects there, and as you have indicated, the power, especially in the Middle East, is going along with the desal plants, particularly in the Middle East.

Chase Jacobson, William Blair.

First, on the capital allocation. Mark, at the analyst meeting, you gave the target for $2 billion of growth investment through 2018 on top of CapEx. You have been through the first quarter. You are still active with the share repurchases. Can you update us on the acquisition pipeline?

It's active in terms of some of the smaller opportunities that you see out there. I think you have read out there some of the larger opportunities in the flow control industry, so there is activity that is certainly picking up.

But in terms of the bolt-on, we stay very focused on looking for the types of opportunities, products, regions that are certainly out there. They just have to meet the return requirements.

And then, from time to time, you see assets go out to auction, but you'll see them right about the same time we do.

Okay, so is there any way to give color on if you are prioritizing technology or geographic footprint or product portfolio at this point?

I think that's just it. It's really -- we want to make sure we have the flexibility to shift across those opportunities, and that's what we're doing.

So in different areas, I can tell you we are focused more on R&D and product development in an area, one, because we can leverage the product technology that we have right now. We can get it to market as quickly as we would like, and either there is no asset available out there or to acquire and integrate that asset creates more risk than taking it to market ourselves.

We have spent quite a bit of capital on further penetrating the Indian and Chinese market to support those markets primarily, but also to support markets around the world. So we have opened in the last year, year and a half a new facility in China, one in India, and one in Brazil, as well.

So I think the point here is that what we're going to do is look for capital allocation opportunities, provide returns to our shareholders, and we will look across the entire spectrum.

Obviously, M&A is more opportunistic. And sure, you can create opportunities by paying up, but then the real question is, can you deliver the value to your shareholder of that acquisition over a period time? And that's what we have to do. So we are moving certainly across all of those, not only with our CapEx dollars, but, as Mike talked about, with our SG&A as well.

One thing I want to be clear on in SG&A, this is not a matter of just going through and cutting costs. This is really a matter of how we prioritize those SG&A dollars to drive long-term value.

Okay. Thanks for that. And then on the competition, you've been talking about it, about competitive market for a while, and I guess we shouldn't be surprised to see it more competitive in the Middle East. But now that that experience is behind you, are you worried about the ultracompetitive environment spilling into the US at all? And is the competition that you are seeing coming from eastern or western competitors?

It's a lot of the same competition that we have seen before. They are good and capable companies.

One thing to keep in mind in terms of competition, particularly in the United States, more the OECD, what customers value is quality, on-time performance and good execution. And so, in the Middle East, it can tend to be oriented a little bit more towards price, although that's changing as well, because if you think about it and if you followed some of the E&C projects from the Koreans that were executed a couple of years ago, they struggled a little bit, and that costs everybody money.

So I think there is an increasing perception, especially in the critical nature of these, that quality and on time is paramount, not at any price. We had a very strong pricing environment 2006, 2007, 2008, but again what I will tell you is that's when economies were growing at very rapid rates, and more important, commodity costs were rising very quickly. So when an owner would bid a project, it would come in 50% to 80% more than what they budgeted for. So that causes the market to try to grab capacity as quickly as it can. It's not always a good situation.

So what we see in these environments, this is typical. We go through multiyear cycles. We started to cycle down really towards the end of 2009. It got very difficult because the industry had little visibility in 2010 and 2011, but you live with that backlog and you see the opportunities start to come. This is not any different from any time before, other than the financial crisis was pretty rugged on all industries.

So as we look at competition, they appear to be very rational, but this isn't unusual as people start to fill their capacity.

Ryan Connors, Janney Montgomery.

I want to add a question on the guidance, if we might. You mentioned at the analyst day, Mark, that the trajectory of bookings in the large project side of the business would be a critical factor in determining whether you end up ultimately at the low end or the high end of the range. And here we are, a few days from May and still at a reasonably wide range there in the guidance. So can you update us on how you are handicapping that relative to the comments you made about somewhat of an acceleration in bookings at the back half of the quarter and into April?

Yes, let me clarify. The conversation at the analyst day was where we would be in the revenue range.

So I think one of the key messages that we want to make sure you take away from this, look at the improvement in the margins. Look at the improvement in the operations, the platform. That's -- you see improvement year over year, which in and of itself, revenue aside, drives earnings growth in the business. So that's one thing to look at in terms of when we look at our guidance.

I think the question I had at that point in time was, how will revenue growth impact your earnings outlook? And what we've talked about is some of these projects, if they are competitive and still have economic value, will contribute some to earnings, but less so than the underlying platform in terms of growth. So I think -- I want to make that distinction. That was the conversation we had at that point in time.

We still think one of the biggest opportunities to drive earnings growth in this business is improving our platform. But clearly and certainly as you take a step back relative to where we were, we sold a business that had some revenues to it. We do need to see increased booking activity to start approaching the top end of our revenue range.

Okay. And then, my second question is just -- you have touched on this a few times on the call here, but just to ask it more, I guess, directly. This whole issue of competitiveness to the environment, is there anything different -- can you contrast, I guess, the environment today versus the last cycle around, and whether things are more or less competitive or whether this is just where you would expect things to be at this stage of the cycle we are in right now?

I think it's where we would expect it to be. If you go back to the last cycle, I think the industry in general got caught by surprise with how economies heated up so quickly and material costs or commodity costs went up fairly quickly. This one seems to be more steadily paced.

What do we mean by typical? Typical in the fact that it is understandable these projects get delayed, because people want to make sure they have their budgets right, that they know exactly what the process conditions are, that any change orders they want to consider to get this thing right, they do. So I think people are very, very thoughtful.

These are 40- to 50-year commitments that these owners are making, and if you looked at the activity back in 2007 and 2008, they were rushing to market as quickly as they could, and understandably so. This is more typical. Long-term spend, long-term commitment, it's not just any one individual's careers, it's many careers that depend on the decisions these folks make. So they are very, very thoughtful and methodical about it as they go through the process.

So it's not typical. I think over the last couple of years, what we did see and you have seen in our industry was 2010/2011, there was little visibility, and that creates some more of, we use the term, choppy behavior at that point in time. That's not unusual, as well, except for the fact that the industry had added capacity and was adding capacity, and in 2010 and 2011 had little or no visibility as to how that was going to get used up.

So, a speed cycle, you saw it creates a little more of a choppy environment during the trough, but we seem to get back -- getting back to more of what you see as steady state in our cycles.

David Rose, Wedbush Securities.

I had a follow-up question on the aftermarket business. I was wondering if you can quantify the size of the opportunity for bringing in house some of your aftermarket support, as in Dow Benelux, and was there any progress reflected in the aftermarket growth that we saw in the quarter?

Yes, there was absolutely progress. Progress in terms of market driven, we talked about earlier, but also in executing on our end-user strategies, and there's a whole array of things that we are doing to try to capture more share of the customer's wallet.

We could and have quantified what the opportunity is internally. That wouldn't be necessarily something I would talk about on the earnings conference calls, but if you take a step back, Dow Benelux is one facility. Think about how many they operate. How many DuPont operates, Exxon, Shell. That really is our opportunity.

And if you take a look at just overall aftermarket, again, I would say the aftermarket was up in many areas. The chemical market was doing very good on the aftermarket side. The oil and gas, we talked about the refineries on the Gulf Coast had started to spend some of the MRO business again, from where they were in the past.

Europe, oil and gas aftermarket was also up, which was a very good sign. Our general industries business was up in terms of aftermarket also, and then, most of the regions fared very well in Q1. Probably the only region that we had a little difficulty with was in Latin America and Venezuela. Other than that, I think it bodes very well for the aftermarket going forward.

Then the last thing, as we mentioned, the distribution business on the valve side also had a very strong Q1 in that area, and we have had a pretty good distribution business on the industrial side also in that area.

I guess my question was really, did you see any benefit of additional opportunities in the quarter that went in house or went from in house to where you were taking care of it?

We didn't announce any during the quarter.

And do we expect -- even if they are small, you won't announce them anyhow, will you?

Those type of relationships, we tend to, if the customer permits, let you know because it helps you understand we're executing on our strategies.

Okay, that's helpful. All right, thank you very much.

Sorry about that, I get emotional when I talk about aftermarket.

Brian Konigsberg, Vertical Research.

I can understand your enthusiasm for aftermarket with those type of margins. But Mark, I do have to push you on the guidance a little bit more. So we are standing here in Q1. Organically, you're down 1%. If I look at what Q1 has typically contributed to the full-year revenue, it is trending below where we would be to hit the midrange of your full-year target numbers, about 4.5% growth range.

Your backlog is flat year over year, yet you're talking the 3% to 6% growth. So, obviously, you are assuming that there is going to be a meaningful acceleration. We are talking about EPD orders maybe coming in the back half of the year, but it's not going to contribute a whole lot this year.

So how should we be thinking about it? What is really driving this? What gives you that confidence that we're going to get there?

One thing is in Q1, even on lower revenues, we delivered more earnings, and we're sitting flat backlog year over year, but, as I talked about, improved backlog with more earnings power in backlog.

I think the third thing to look at is look at the growth in our aftermarket business even over the last two quarters. We have seen good growth there. And then, the trajectory of the platform, so we are not done improving this platform, as well.

I think the other thing, the comments earlier, aside from the aftermarket, is as these project opportunities come, there is run rate business that goes with that, as well. So I think you piece all those things together, and honestly, Brian, there is an aspect of share count year over year as well that we get a benefit from. That's what, at this point, gives us confidence in our guidance.

But just to follow on that, I appreciate the improved margins in the segments, but if you look at Q1, you did get a meaningful tax gain, which I don't think you were anticipating. You got the gain on the sale of the asset, so operationally, you are actually running quite a bit below, I think, where you expected the run rate to be. So I don't think your guidance initially anticipated those benefits, and it seems like topline actually would have been a meaningful driver to get you operationally where you thought you would be. Is that not a fair view?

No, if you even normalize the operating income, it improved on lower revenues. So take all the items aside, let's not even talk about the tax, and you can see the improvement driven by the improvement in gross margin and the other one, the operating and the leverage on the SG&A, as well.

Now to your point, especially around fixed-cost leverage in the SG&A line, do we get benefit from topline growth? Yes, because we leverage it. We can leverage it in our factories, our gross margin, so there is certainly improved benefit. But if you look, being able to improve our margins on a normalized basis compared year over year on declining revenue, that shows you the power that you may not be fully observing in the improvement of the platform, and just even the growth of the aftermarket bookings over the last two quarters.

Joe Giordano, Cowen.

Thanks for taking the question. Just one last one maybe on aftermarket. So last quarter was all-time high aftermarket. This quarter, all-time high for a 1Q. How do you look at the timing of conversion there? And how would you balance on a margin level maybe to what we expect to be a short-cycle conversion from that OE, how would you balance that with expected OE growth in the back half of the year at more of a dilutive impact to that? How would you categorize the whole -- the trend through the year on the overall operating margin?

More on the gross margin than the operating margin, because if you get project-related revenues, you tend to get better fixed-cost leverage in the SG&A line for that.

But we talked about this before. If you looked at historically when we reported the seal business, add 40%-plus gross margins in the business, and so you can see it certainly has a margin enhancement.

So, a mix shift in original equipment to aftermarket, all other things being equal, assuming there is no improved operations or anything like that, is 25 to 30 basis points of margin. That's it on the gross line.

We want really to drive all of it. What we want to do is make sure we have profitable projects that come through in the business. Again, we can increase bookings that you see, but if we take things at zero profit or potentially at a loss in the operating line, we don't think that benefits anybody at this point in time, because we are not concerned short term about absorption issues.

So as you look at that, we want to continue to grow that aftermarket business. It does tend to cycle through over, max, a couple of quarters. Run rate business will tend to cycle through a little bit longer, and then projects, we do get percentage of completion accounting, but those things will tend to execute over a year, year plus.

Okay, and then one question on chemicals. So we saw year on year, it was about a 300 basis-point mix shift on the bookings there, so something like 15% year-on-year growth in chemicals. Maybe if you can give some color as to where that's coming in, which segment you are seeing that kind of big increase. And is this the OE from the ethylene products that have already been handed down to the E&Cs? So, I guess, maybe that's getting hit in the OE decline in EPD?

Yes, the ethylene projects are a part of it. We are starting to see those projects start to come in.

If you were to look overall at chemicals, up about 15% for FLS overall, and the business, it was up in EPD quite a bit, so that was EPD, and it was up in IPD also. In chemical, in FCD, it was just slightly down, about 2%.

So two of the business where the power house destroyed the chemical business. And besides the ethylene projects, we're getting the shale gas finds in the US driving all the chemical business, primarily in the US, and you are also seeing some chemical business driving in the Middle East. They, again, diversified their overall business to get into the chemical business.

So I would say Middle East and North America where the two primary drivers, along with EPD and IPD, in that business.

Scott Graham, Jefferies.

So the pickup in bookings that you saw in March and April, one of the things that we understand is that the Company's optimism on the timing of project releases to EPCs is incremental -- a little bit better because of what you are seeing in Europe and the Middle East. I was just wondering, is that the same thing? Is your optimism on the timing of the rest of world or those areas of the world bookings bleeding -- running through your bookings now?

Let me see if I understand the question. We talked about seeing these opportunities out there, and I think a lot of the comment has been focused around North America. And I think during the analyst day, Scott, you saw some of the awards to some of the E&Cs. You were saying we would anticipate seeing some of that towards the back half of this year from the North America.

If you go around the world, those are a set of different conversations that either give us optimism or concern over a period of time. For example, in the Middle East, some of the upgrade requirements we talked about in Kuwait and some of the projects that we have seen out there for a while, and in Europe, a lot of that is going to be more around the economy. We don't expect that they're going to build any new refineries, but it will certainly support some of the run rate business, the power industry as well, and some of the things that they're doing with the chemical as well.

Understood. I wanted to ask you a little bit more about the run rate business, Mark, because we have been using that phrase now for a couple of quarters. You gave a couple of examples early on in the call about what that is exactly. I guess my bigger question is, what are the signs that you are seeing there that suggest that can continue at the pace of growth that it's currently running at?

One is just the growth we have seen fairly consistently over the last couple of years in that business. Another one is the improved execution. Those are the kind of pieces of equipment that a customer needs quickly, on time, and to operate the way it needs to operate. And when IPD wasn't executing to that level, honestly, they had to turn away some business.

So I think those are some of the encouraging signs that we are seeing.

The other thing that we would look at, we talked about a minute ago, was the distribution channel. In 2008, they started destocking. That will tend to put pressure. It will flow through into that run rate business because that -- oftentimes, that is where some of that configured order product tend to go through.

The other thing we added in our comments earlier, Scott, is oftentimes some of the run rate -- this can be some of the configured order process equipment -- will go along with projects as well. So on project opportunities, IPD does participate. If you look at a balance of plant type investment, some of those run rate products will go in there.

And I think the other thing, frankly, one example is we told you three or four years ago that we had not properly targeted an R&D opportunity in the ISO chemical pump. We got that product up and running, and it's doing well.

So those are some of the things, but I think really from our standpoint, what it comes down to, externally we looked at project opportunities. We look at the distribution channel. We do look at some of the drivers in economies, because some of this run rate product goes into small upgrades and repairs and replacements in Europe and in the United States and other regions.

Internally, we look to opportunities around how we are aligning our sales organization, products we have developed that we've invested in and how we are taking them to market, the acquisition that we made of a mag-drive product that we can load onto the platform, and then at the end of the day, it comes down to execution.

Understood. Last question is this. Earlier today a company in your space, not necessarily a competitor, per se, reported that the power business, their power business, had started to accelerate in the Middle East and Africa. I was wondering if you were seeing the same.

Tom.

Yes, if you take a look at the power business, a lot of that is tied to desal business in the Middle East. And also, it's tied to the combined cycle business in the Middle East. I would say those two drivers there. And Africa does have some desal business going on there, and as you know, those plants take a lot of power in order to operate. I would say you are correct there.

Okay, thanks a lot.

We have no further questions at this time. I would like to turn the call back over to Jay Roueche for any closing remarks.

We again appreciate everyone's participation today. If you have follow-up questions, please call Mike Mullin or me, and with that, Ellen, we have concluded today's call. Thank you.

Thank you. Ladies and gentlemen, this concludes Flowserve's first-quarter 2014 earnings conference. Thank you for participating. You may now disconnect.