福斯 (FLS) 2016 Q1 法說會逐字稿

Welcome to the Flowserve 2016 first-quarter earnings call. My name is Christine and I will be the operator for today's call.

(Operator Instructions)

Today's call is being recorded. I will now turn the call over to Mr. Jay Roueche, Vice President, Treasurer and investor relations. You may begin.

Thank you, operator, and good morning, everyone. We appreciate your participating today in Flowserve's 2016 first-quarter earnings call. Joining me this morning are Mark Blinn, Flowserve's President and Chief Executive Officer; Tom Pajonas, Executive Vice President and Chief Operating Officer; and Karyn Ovelman, Executive Vice President and Chief Financial Officer.

Following our prepared comments, we will open the call to your questions. And as a reminder, this event is being webcast and an audio replay will be available. Please be aware our earnings materials do, in this call will, include non-GAAP measures. Please review the reconciliation of our adjusted metrics to our reported results prepared in accordance with Generally Accepted Accounting Principles, which can be found in both our press release and the earnings presentation.

Please also note that this call and our associated earnings materials, contain forward-looking statements which are based upon forecasts, expectations, and other information available to management as of April 29, 2016. These statements involve numerous risks and uncertainties, including many that are beyond the Company's control.

And except to the extent required by applicable law, Flowserve undertakes no obligation and disclaims any duty to update any of these forward-looking statements. We encourage you to fully review our Safe Harbor disclosures contained in yesterday's earnings materials as well as our other filings with the Securities and Exchange Commission, all of which are available on our website at flowserve.com in the Investor Relations section. 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. Flowserve's first quarter results were largely as expected, and in line with our cautious outlook discussed on last quarter's call. I will cover a few highlights then Karyn will take you through our financials in detail.

Let me begin by stating that despite the current challenging macro environment, we remain on pace for the year with our adjusted EPS of $0.39, which included the increased seasonality impact that we expected as well as approximately $0.07 of distinct expenses in the SG&A line. Our adjusted operating margin fell to below 10% for the first time in a while and included the 140 basis point impact from the distinct SG&A expenses.

This margin performance demonstrates that cost efforts lag in a declining revenue environment, and the loss of fixed cost leverage results in increased underabsorption in addition to the normal decrementals. We do, however, expect our margin profile to improve for the full year, particularly in the back half, as a result of the expected increase in volume, as implied in our full-year revenue guidance, as well as the building cost savings from our realignment and integration efforts.

In the current market environment, we are focused on controlling what we can. As we previously discussed, we are taking aggressive action through the acceleration of our planned structural cost initiatives to optimize our global manufacturing presence as well as adjusting to current levels of customer capital spending.

Considering the size of our overall investment in this program, let me review some of our efforts. To begin, to simplify the tracking of our realignment programs, we have now combined our $350 million accelerated manufacturing optimization strategy announced last quarter, and the nearly complete $50 million SIHI realignment effort into a single initiative.

So we will now refer to a $400 million investment expected to generate $230 million in annualized cost reductions once completed at the end of 2017. We made solid progress on our realignment initiatives in 2015 and continued this trend in the first quarter. While some disruption and delays are expected in pursuit of a program this size, I am pleased with the focus demonstrated by our employees to minimize customer impact and to deliver on Flowserve's commitments.

During the first quarter, we achieved approximately $16 million of realignment savings compared to our year-ago cost structure. And, we remain on track for the planned full-year 2016 savings of $125 million. Some of the major developments of the program include to date, we have notified 13 plants of our intent to close, downsize, sell, or repurpose those facilities.

Nine were notified last year, with two of the smaller ones completed in 2015; and the others expected to be completed later this year. This year, we have also notified four additional plants, including beginning discussions with the appropriate parties on the proposed closure of a French facility and our plan to relocate those capabilities to other Flowserve facilities.

The closure of a US plant whose capabilities will be moved to our Pasadena, Texas location, with expanded manufacturing capabilities, and synergy benefits. Consolidation of two Chinese facilities into one, to generate cost reductions and to leverage capabilities in our newer Suzhou location. And early in the second quarter, we announced the planned closure of the former SIHI Colombian location whose capabilities will be moved to other facilities in Latin America.

As you can hear, since the initiation of our realignment efforts, we have addressed numerous facilities and aggressively focused on aligning SG&A to current market conditions. We also recognize that these decisions affect our people, and therefore, are never easy. So each action we take is thoughtfully and carefully considered.

Our facilities, however, are not the only area affected, as we also continue to delayer, simplify, and upgrade Flowserve's leadership organization, which include some non-realignment severance expenses. While it takes time to take these costs out, largely due to the regions where most of the actions are occurring, we are proceeding with a sense of urgency.

At the completion of our $400 million program, we ultimately expect a 15% to 20% reduction in our global workforce relative to early 2015 levels. All in, these action will help Flowserve to become a leaner and more streamlined organization, enabling us to expand our competitive advantages and ensure our ongoing leadership role within our industry.

Turning now to the current market and bookings within our served industries. The recent increases in and stability of crude oil prices is generally a positive development for our markets. But macro uncertainty continues to impact our customers' spending patterns, particularly as it relates to decisions concerning and the timing of capital investments.

However, we fully expect the longer-term growth patterns, in our served industries, to continue to rise. The world's population, urbanization trends, and the resulting demand for energy of all types, all demonstrate a solid growth forecast and give us confidence that Flowserve is targeting the right markets.

We are increasingly encouraged by the improved aftermarket activity we saw towards the end of the first quarter. And we believe that our core aftermarket activities of parts, services, and repairs are stabilizing at these levels. As our markets return to their regular maintenance schedules, we expect to benefit.

Now looking at our served end markets and bookings trends. While the market challenges of 2015 persist with many of our customers tightly managing their budgets, we are generally pleased with our book-to-bill of almost 1 and holding backlog at year-end levels. Project bidding activity has picked up as of late in some areas, and after a slow start to the year, March bookings demonstrated improvement.

We do, however, continue to expect project opportunities to remain limited and competitive. So we will remain disciplined in our pursuit. Overall for the quarter, constant currency bookings declined approximately 8% year over year, primarily reflecting lower project awards.

Sequentially, however, our bookings declined only 4% which is significantly better than the typical sequential decline we experience in a first quarter. We are encouraged by essentially flat constant currency aftermarket bookings, as compared to both last year's first and fourth quarters, demonstrating the resiliency we expect in our core aftermarket franchise. Project awards were down significantly year over year, and particularly in IPD.

But partially offsetting this were some of the benefits we've delivered from our commercial initiatives and activities that we have discussed. Our view remains that the maintenance deferral environment we've experienced since early last year provides a building opportunity, since much of this work cannot be pushed indefinitely.

We also expect that the longer delays and deferrals will result in a greater level of work required when facilities are actually brought down. While we did see some of our customers that deferred in 2015, move forward in the first quarter, we continue to expect some 2016 planned takedowns to defer until next year.

Large project opportunities remain limited, although we have seen some pockets of improved bidding activity. However, we expect that those progressing will see an extended timeline to final investment decision and the bidding environment will be competitive.

Looking at specific end markets, we delivered solid growth in power bookings, which were offset by lower oil and gas bookings and to a lesser extent, chemical declines. Power bookings increased nearly 19% on a constant currency basis, driven by strong combined cycle investment in North America and elsewhere, in addition to meaningful desalination project wins.

This quarter, we benefited from our ability to successfully shift certain products traditionally focused on oil and gas markets towards our power customers. In our general industry segment, constant currency bookings increased 3% on strong pulp and paper activity in FCD, including greenfield projects in emerging regions and capacity modernization of existing facilities.

TI also benefited from some progress in IPD's distributor initiatives, to utilize this channel, to target previously unserved markets. Broadly speaking, we believe destocking has largely occurred and distributors are now maintaining inventory at lower levels, and ultimately, we expect restocking to be a tailwind.

Oil and gas markets generally remained under significant pressure. However, pockets of bidding activity continue in the Gulf Coast region particularly as it relates to LNG export facilities. These LNG projects are at various phases and approval stages, with some developers pursuing offtake sales agreements before moving forward.

Refining maintenance spend appears to have stabilized and we expect some improvement in the second half of 2016. Middle East activity has slowed in the last few quarters, following its relative outperformance in 2015, particularly in the first half of last year.

Chemical markets continue to be impacted by project delays on new ethane crackers, even as they are supported by low cost feedstock in North America and the Middle East, and the downstream derivative facilities are also being slowed.

Similar to our refining customers, maintenance deferrals appear to have stabilized. And we are now beginning to see some benefit from parts spend on new facilities brought online in the last several years.

To wrap up, our outlook for the remainder of this year is one of expected market stability. Our first quarter results were largely in line with our expectations and we began to see signs of improvement in certain markets. We expect limited project activity and for those progressing, increased price competition.

We were pleased with the early results on some of our growth initiatives and the progress in our industrial activities. This, together with Flowserve's proven track record of navigating challenging conditions, and reacting quickly on the cost front, while maintaining financial flexibility, and a disciplined focus on investing for the long-term profitable growth, gives us confidence in our ability to drive long-term value for our customers and shareholders. Let me now turn the call over to Karyn.

Thanks Mark. As we've highlighted, first quarter results kept us on pace with our full-year expectations outlined in February. We discussed at the time that our 2016 first quarter would be challenged beyond our normal seasonality due to industry headwinds experienced in the 2015 fourth-quarter, which continued into the first months of the quarter.

First-quarter adjusted EPS of $0.39 was driven by a solid level of shipments and continued operational performance. Our adjusted results included approximately $0.07 of distinct SG&A expenses, primarily related to accelerated non-cash SG&A accruals in the quarter from modifications to new long-term incentive plan grants.

We also saw negative currency translation of approximately $0.03. Following our announced definition, adjusted EPS excluded $0.07 of realignment expense; $0.02 of negative below the line currency effects, and $0.01 of SIHI purchase price accounting and integration charges. Adjusted SG&A expenses appear elevated during the first quarter but we do not believe this represents the trend.

First, we are including the $13.1 million of distinct SG&A expenses, primarily related to the non-cash accruals I mentioned, which will not recur in the remaining quarters this year. We also had some non-realignment severance in the quarter, as we look to upgrade certain roles. There is also a timing-related impact associated with our cost reduction efforts where we've identified comparable savings but they haven't been fully realized in the quarter.

As Mark discussed, many of our actions are in high-cost regions and will take longer to achieve. So as the year progresses, we expect our adjusted SG&A percentage to be below the 24% we saw in the first quarter.

Turning to margins, first quarter adjusted gross margins were 33.3%, which excluded realignment charges of $7.2 million. Gross margins were negatively impacted by lower volumes, increased underabsorption, and a beginning backlog that reflected the pricing environment of work booked in 2015.

Adjusted operating margin of 9.4% excludes $13.5 million of realignment and $1.3 million of SIHI purchase price, accounting and integration charges. If we further excluded the distinct corporate expenses, adjusted operating margin would improve to 10.8%. Our IPD segment was particularly affected this quarter.

A sales decline of nearly 12%, with many of its facilities in high-cost regions, increased our underabsorption. We are attacking this headwind, however, through our realignment initiatives. We also saw about $4 million of non-comparable cost this quarter.

Finally, while we continue to be pleased with SIHI's revenue and gross margin profile, incorporating its business performance into IPD was dilutive to the segment's operating margins this quarter, as reducing SIHI's SG&A has been pursued methodically and will be more back-half weighted.

Our first quarter tax rate of approximately 31.6% was slightly above our full-year guidance rate of 30% to 31%. On a constant currency basis, our bookings in the first quarter declined 7.8% year over year and 4.3% sequentially.

Constant currency original equipment bookings declined 14.6%, as customers continued to delay and defer capital projects. And as previously mentioned, aftermarket bookings were essentially flat.

Regionally, we saw good constant currency growth of 11.5% in Asia-Pacific and a modest 1.4% increase in the still struggling Latin American region. Middle East and Africa expectations experienced the largest drop, both in terms of dollars and percentage while North America and Europe were down single-digit percentages.

First quarter sales of $947 million were down 6.6%, or 2.1% excluding negative currency effects, primarily on strong EPD OE shipments; constant currency aftermarket sales were flat.

By geography, we saw significant sales improvement of nearly 35% in the Middle East and Africa, reflecting solid bookings there in 2015. In North America and Europe, both declined single-digit percentages while Latin America and Asia Pacific sales declined above 10% on an FX neutral basis.

We've discussed some highlights of our realignment actions and noted the combination of our manufacturing optimization program with the SIHI realignment efforts to simplify reporting. To be clear, the overall size of our program has not changed versus last quarter. To cover some numbers, since initiation of our realignment efforts in early 2015, we have expensed approximately $130 million, including the 2016 first quarter charge, $13.5 million.

For full-year 2016, we expect total charges of approximately hundred $160 million, with achieved savings of approximately $125 million, including approximately $16 million achieved in the first quarter. In total, we expect our $400 million investment to drive total savings of $195 million in 2017 before achieving full annualized program savings of $230 million in 2018.

Turning to cash flow, first quarter operating cash flow improved $85 million as compared to a year ago. Free cash flow increased roughly $150 million, or over $1 per share, further benefiting from $64 million of reduced CapEx. Our realignment program used approximately $24 million of our cash during the first quarter and we also returned $23.4 million to shareholders through dividends.

Turning to our 2016 outlook and EPS guidance, we are reaffirming our full-year adjusted EPS guidance of $2.40 to $2.75 a share, following the first quarter's in-line performance. Our 2016 adjusted EPS target range expects total revenues to decline 7% to 14%, including a 2% currency headwind, or roughly $0.10 of above-the-line impact.

Guidance further assumes net interest expense in the $63 million to $66 million range and a tax rate of 30% to 31%. We also expect the second-half weighting of our earnings to be more pronounced in 2016.

As a reminder, our 2016 adjusted EPS guidance includes the operational performance of SIHI and excludes realignment expenses, SIHI purchase price accounting and integration costs, below-the-line foreign currency effects, and the impact of potential other discrete items.

We also expect that 2016 capital expenditures will decline compared to the elevated 2015 level when we increased manufacturing capacity in Asia-Pacific and purchased a license, enabling increased aftermarket opportunities. We expect cash expenditures associated with our realignment program of approximately $150 million during the year.

We also plan to continue contributing to our pension plans to cover service costs, even as the US plan is largely fully funded. With that review, let me turn the call back to Jay.

Thank you, Karyn. Operator, we've now concluded our prepared remarks and would like to begin the question-and-answer period at this time.

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

(Operator Instructions)

Mike Halloran, Robert W. Baird.

So first, could you give us some more context around the improvement you saw in the March order rates. Do you think it's a sign that maybe outside the oil and gas space, in particular, there's a little less fear, maybe more willingness to bring CapEx back to the market? Was it -- was the trend more than normal seasonality? So just a little more color around that improvement, please.

Yes, we always see a little pickup in the month of March. Mike, what -- if you remember, mid-February, look what happened in the markets and in the price of oil; there was just a complete lack of visibility at the first part of the year.

So you typically see a trend up in March as particularly in some of the emerging parts of the world that get their budgets approved and everything but for us, we saw a kind of not back to what I'd say normal levels but certainly some improvement, particularly on the aftermarket side and I've seen it continue into April as well.

So I would say it was stabilization, reflecting kind of the current market environment. What we saw towards the end of the year last year and really, in the first six weeks of this year, was something more akin to what you saw in 2009, in parts, and there was not a lot of visibility.

So Process operations have to continue to run and as long as things are flowing through and they have to do that but there are still times when people kind of stop, and wait-and-see and we saw that in 2009 and we saw it at really the last month of the end of last year in the first six to eight weeks of this year as well.

So we're keeping an eye on it. As I made in my comments, you've seen oil certainly stabilize; remember at the beginning of the year, they were concerned about oversupply, lack of storage and demand destruction in China.

So some of those things have certainly abated. You see the price kind of stabilize. It will still move around. But as this occurs than people can kind of get back to life, so to speak.

So then when you think about growth and the return of growth, aftermarket is starting to become a little bit more normalized for you maybe even starting to improve sequentially. Some of that deferment starts to -- at least dissipating bit. The OE side is starting to stabilize, so from here to get growth in 2017, what would you need to see different or just a continuation of the trend, maybe just talk about some of those dynamics?

Well, as we kind of think of growth in really the three areas we talk about on the aftermarket, it is going to be the pent-up demand being released and not further demand being pushed out. And we talked about that a little bit but some of that coming back online, and then executing on our aftermarket strategies. Keeping in mind that over the last seven to eight years, the growth that we've seen has not been -- it's been market driven to a certain extent but more so around our strategies.

When you look at the run rate business, I think there's a couple of things to that. Executing our industrial strategies, we did see some good improvement and some traction in Q1 versus where we were last year. So executing our distribution, focusing on our channels market, our e-Commerce to drive growth, in that business, also some brownfield activity. If you look at it, maybe some destocking ha, s for the most part, occurred. Maybe there's stock levels that come in and a little more activity around brownfield, both direct and through our distribution channel.

And I think the last piece, Mike, that what we need to keep an eye on is the larger project activity. While typically the lowest margin business, that's something that can move your topline the most. What we've seen is projects, there are some projects that are still out there.

Some that we had an opportunity to bid on in Q1. We just didn't like the terms and conditions, but they're out there. It's really keeping an eye on what's goes on the drawing board, in terms of next year, that maybe come to bid.

That's where we're still trying to get some visibility. And I wouldn't have expected that to snap back after what we went through in the last six months. But that's what we need to keep an eye on is, are they going to put some of these projects on the drawing board and start to work them up?

Thanks for the time, Mark.

You're welcome, Mike.

Andrew Kaplowitz from Citigroup.

Mark, I wanted to ask you a little bit more about the bookings in the quarter from the standpoint of specifically in power and general industries, where's the power stream coming from. I know you cited the combined cycle US market is improving, maybe China, nuclear is improving; goals maybe but are you trying to signal that those end markets are getting better here? And are you also seeing a bit of inflection in that general industry business. I know it's a hodgepodge of businesses but you mention pulp and paper. Are you seeing better sort of environment for general industry as well?

Well, I think the -- in the power, it is the combined cycle, some of the other projects. I mean you've seen over the last couple of years, power has been challenging, relatively flat; now you're seeing investment go forward. And if you look behind all this, we talk about this oftentimes the secular drivers, I mean people need more power; there's not a sufficient amount of power.

The infrastructure has aged. So you know these things will kind of come back around. It's been kind of soft over the last couple of years but you've started to see some investment generally. Combined cycle in the US with the focus on fossil fuels and also in emerging parts of the world.

In the general industry, there's certainly been some self-help around our focus on our distribution channel. That typically is reported in our general industry segment. Also, as you saw a couple of years ago, there was investment in the agricultural industry. Pulp and paper is kind of having its moment right now. So these things do tend to cycle through and come around.

In general, what you'll see the GI is going to track the distribution channel, and then also certain other markets as well that will tend to see investment from time to time. But the way I'd look at that is what strategies are we executing around our industrial side and also in our distribution channel.

And as for the other parts of our business, on the chemical side, certainly we see investment opportunities as you saw back in 2010 after a market decline, so you'll see investment. The one we've got to watch is the big projects on the oil and gas side.

(multiple speakers) I would add maybe a little bit to what Mark said. In addition to the combined cycle resale, you have a little bit more, I would say, push going on in the renewables, solar, biomass, waste to energy, so that's -- we're starting to see just some turn there slightly.

And also, I would say China nuclear, there's plans for a defined build-up, a defined build up over the China nuclear over the next several years. And even though the coal market is going through a transition, that may spur a lot of carbon sequestration projects as they look for clean coal opportunities going forward.

Got it. Okay, that's helpful. And Mark or Tom, can you talk about the progression of your savings initiative. When you reiterated the savings targets and you recognized only $15 million in savings in the first quarter. Is your target still $125 million? I think that's for 2016 but I think that includes SIHI amount. So how concerned should we be that savings could be pushed to the right a little more into 2017 and given part of the reason to get costs down is to compete in a more difficult pricing environment, how concerned are you guys that margin could still get a little worse before it gets better.

Well if you look at it, a lot of these costs are in the high-cost regions in, and particularly in Europe and it does take time to get those costs out. So we -- you see times when you are ahead of expectations and behind expectations. At this part of the year, sitting in April, we're still confident that we're going to be able to drive a lot of these costs out or get them teed up to drive them out during the course of this year, as we've talked about.

But certainly, in the first quarter you saw the lack of fixed cost leverage, particularly in the G&A line, and a lot of that is just that it takes time to drive it out of the business. But for the specifics, Karyn?

Yes, let me give you a little more granularity around how this will flow through. So $400 million cost, approximately 80% of that relates to closures or capacity reductions and that will represent about half of those run rate savings.

And then the headcount reductions, which really are less than one-year type paybacks, that's about 20% of that overall cost and about half of those savings. So Q1, just to roll through here, Q1, $13 million; 50% of that, cost of sales; 50% of that, SG&A.

We expect that of that cost of sales 50% of that SG&A, we expect that ratio to kind of range between 50% to 60% as we forward into cost of sales and 40% to 50% into SG&A As we indicated in our comments previously, inception to date expenses about $130 million; so of that remaining $270 million, about 55% to 60% in -- for the remainder of 2016 and the rest will be in 2017. So you can continue to expect that split between cost of sales and SG&A.

Year-to-date savings in 2016, about $16 million and we expect that savings to increase over 2016 so definitely weighted heavy in the back half of the year. Then the run rate savings, we expect it to be around $230 million by the end of 2017, or early 2018, and expect savings of a little bit more than half that amount in 2016, $130 million; and that's all grown to about 85% to 90% in 2017.

And so, Andy, one other thing to keep in mind in the cost of sales oftentimes, those savings will take the cost out but they'll be capitalized in the projects. So in terms of when it's a P&L. But I think the bottom line on this; this is an absolute priority for us.

This is very significant. We think it's going to really position us very well for the future so we have a lot of resources on this so that we can achieve the commitments that we've talked to you about.

Thanks, Mark.

Nathan Jones, Stifel.

So this is about as bullish as I've heard you in a couple of years, Mark. So I guess, even potentially a little bullish here on the large project business. Can you talk about maybe what your customers are telling you in terms of their plans to bring some of these things back to market?

What you're seeing in terms of behavior from your competitors on pricing? Just your general outlook on that going forward.

Well, you tend to be encouraged when you see some stabilization after the last six months that we've been through, or actually the last, what, 15 months that we've been through. I'm certainly not calling the ball that good times are here, like they were certainly two or three years ago or more particularly, in 2008.

But we are encouraged by the stabilization, and I think I'm also encouraged; it's always good when you see some of the initiatives that you have start to take hold, in particular, in our Distribution and Industrial segment. I think Nathan, when we were together we talked about that a little bit.

But what I do want to make it clear on, on the project side, as I mentioned earlier, there is some activity these things have been on the drawing board for awhile. We expect them to become very competitive; we'll need to be selective because we definitely can compete. We want to position ourselves to but we need to be disciplined.

I do want to express just my concern is with oil and gas, the way it's been, we just haven't seen things going on the drawing board that we want to see. They can come back online but that area, we're still definitely cautious about.

From a pricing standpoint on the projects, we should -- we expect that to be competitive. Look, we've taken that approach for the last nine months to a year-plus as we saw this market. This is why we're taking the aggressive actions in our cost.

A big part of our cost reductions are in our custom engineered business, which addresses these projects. We want to participate in these projects. That's what creates install base; that's what gets you in front of your customers.

But we know that we need to really drive costs out of our business so we can remain competitive, not only in this environment, but we can drive good profitability as pricing improves in the projects. So it's -- that's kind of our outlook.

Generally, as you've seen with the integrateds, they are all focused -- they continue to be focused on the dividend. They've gone a little more, I think, tailwind to them. But they're focused on price as well; so are we.

Keep in mind, these projects are competitive, but if you look across the rest of our business, we're turning to our supply base as well. So we're passing through a lot of that on the smaller business down to our supply base.

I know you mentioned we talked about this earlier in the year. I think it's one of the more interesting initiatives going on at Flowserve and I know you've got a new later in IPD. Can you maybe give everybody a little bit more color on that growing distribution through in -- for IPD, initiative what progress has been made? What kind of opportunity you think that is?

We started to see progress this quarter. So I wouldn't necessarily claim victory on that. What you're seeing in IPD is it is shifting truly to an industrial business. If you thought about my prepared comments, year over year, we saw a significant decline in projects, large projects particularly in the oil and gas, so IPD kind of rode the, for many years, the oil and gas coattails, as it emerged out of the pump business a number of years ago.

We saw, but half of that decline was offset by traction in our industrial initiatives and also we've been very pleased with what we've seen from SIHI. The top line has held up well and the gross margin has as well. On the SG&A line, we've been very thoughtful in terms of what we do with that. We've been able to leverage it.

That -- those costs will take time to get out so as we take a step back, and think about the products that we brought in there over the last couple of years, we were under utilizing our channels to market. Both INNOMAG also and we learned a lot from the SIHI acquisition.

So from our standpoint, we're encouraged with what we see. It's -- we need to grow that business, we talked about that a couple of years ago. And that's what we see in the business.

Is there any way to size the opportunity, I mean you've talked about that being an unserved market for Flowserve. Can you size the market? Can you size kind of what you're going out, going after in that market at all?

Market, like the industrial market? (multiple speakers)

Yes.

I mean it's -- it addresses the chemical industry. It -- I mean, there's multiple applications. I mean much more opportunity certainly in the chemical industry. For example, if you look at the vacuum pumps that SIHI has, they were primarily focused on the European market.

So European market is good, but the Chinese market, even the US market, is strong as well. So the opportunity is big.

And I would add, Nathan, to what Mark is saying is, when the opportunity comes through distribution and the industrial side on the range of products. So increase the range of products that's going through the distribution side of the business. It's a regional play, EMA was a very good, stable growth on the distribution side, and it was because of the new territories that we started to look at and service through our distribution business, including Russia.

It's also a play on the strategy of matching what the customers needs are to the type of distributor that you need in that particular territory. So it's a little sophistication on the distributor strategy in those areas, region, products and customer drivers.

It's early days on that, Nathan. There's other companies out there that have very good products, very good channels and do quite well and have high margins in their business; that's what we aspire to.

Charlie Bradley, SunTrust Robinson Humphrey.

Just on the IPD, can you just talk about -- I'm not going to get too specific, because you won't -- the margin improvement to that business. I mean it took a pretty big hit on the margin in Q1 relative to where that business has been and all these absorptions hitting that.

But as you go through this year, do you get it back to a double-digit margin and as we get into 2017, further improvement on that or is it structurally, it's going to be kind of a slower crawl back up to that?

Well, no, this isn't reflective structurally of that business. What you have in the IPD segment this quarter is a good portion of those discrete expenses were in that segment. And also you have the SG&A burden from SIHI which will drive those costs out in the back half of the year.

So it's not really reflective. Also, if you look year over year, the revenue decline, it -- we need to get those SG&A costs out; part of those are in high costs. So there's a lot of things working, the revenue decline, the impact of the discrete SG&A items in the Q1 and as Karyn talked about, those don't occur in the other quarters and also the impact of SIHI.

All of those things in a sense impacted margins during the quarter. But if you look underneath in the business, the gross margins held in there fairly well. The underlying SIHI business was strong; we were able to offset some of the significant oil and gas project declines. So that's really representative of how that business looks. We expect it to improve.

Okay. And can you just talk on a more macro sense in terms of competitors, given the downdraft in some of oil and gas market in particular, are you seeing any different reactions from competitors, either the positive or negative to Flowserve's business?

No. I mean it's -- where we see them mostly is going to be on the big project side and that is each competitor is making decision for their own reasons as to how they're going to approach a project. It could be absorption; it could be a desire to get the install base.

If you look particularly, in some of our run rate business, it's -- there are fairly large markets and the real issue there is making sure you're responsive to your customer, that you can give them the product that they want. What we do like is we have a broad array of products in our portfolio. And you've got to execute well on the channels.

Well, we found that we've struggled particularly in our IPD segment going back to five, six years ago it's when we haven't really taken good care of the customers. So that's really the opportunity that we and our competitors look for and that's why we're so focused on these initiatives.

Great. Thank you.

Scott Graham, BMO Capital Markets.

Mark, one comment. I really wish Karyn had a better handle on the numbers. (laughter) I'm going to have to go back to the transcript to see what she said. I couldn't keep up. I put my pen down. So I want -- very well done, Karen. I wanted to ask you a question about some of the dynamics of the bookings. In both Flow Control and particularly in EPD, there were some pretty rough and tumble organic bookings numbers in the last four quarters and if -- maybe if we start with EPD.

Despite that, we've had organic sales growth in each of the last two quarters and not organic sales growth in the last two quarters in Flow Control, obviously down, but the degree of the bookings decline even there would suggest that really the next couple of quarters, we could see a pretty significant reversion in sales there.

Is that the right way to look at it there? Because it would seem that the bookings -- that the shipments are going to have to catch up to the weak bookings at some point in both businesses.

Well, in EPD, what you've primarily seen is the big project activity. So as we talked -- that's been the bulk of the decline so the underlying aftermarket business year over year and sequentially, the sales were relatively stable but you saw the project activity that we booked in 2014, those compares across it.

On the FCD, it tends to be shorter cycle businesses and so you feel the impact of the bookings quicker, much more-- quicker in terms of book to ship so it's -- I think if that's answering your question, I just want to make sure it is, that's typically what's driving it.

Yes. It is in part but it suggests to me that I mean if your sales guidance for the full year is down, 7% to 14% in this quarter you are only down 7%, it would suggest you guys are bracing for weak, slower year-over-year sales or weaker year-over-year sales declines in at least the next couple of quarters. That's what I'm trying to understand.

Go ahead, Karyn.

I think as you go through the year, you have to look at first quarter and you have to look at it from the percent of revenues that we have in the first quarter. And so going forward, you have to kind of weight that a bit. But expectation, as we move through the year, we will have increased revenues in the latter part of the year.

Seasonally, that's what we had experienced in the past as well. The key for us, as we go forward, as you drop down through revenues is looking at margins and looking how our realignment activities and underabsoroption starts to improve in the latter part of the year.

Part of what can help you and I'm sorry, I'm struggling with your question, because I don't think I understand it, but if you look at the book-to-bill, often that can give you an indicator. In the shorter cycle, that will help you with the trend on subsequent quarters.

But clearly, what you've seen is the book-to-bill in the OE and the EPD segment has been impacted by the lack of projects so you see that reflect through on the revenue side. That formed a lot of the basis of our revenue guidance this year. Because last year's revenue had a lot of project activity that was booked in 2014.

Okay. I guess what I'm trying to get at here is that it seems like there has been an improvement in that sort of great middle. The -- not the project, not the aftermarket but in fact, the book and ship business. That trend line seems to have improved and if it hasn't, then it would seem that the sales declines in, at least engineered products, are going to -- you'll start to see sales declines in the next three quarters in that business for sure. That's what I'm trying to get a handle on.

Yes. In the project side, we do expect it, and as I said, that forms the basis but even if you look in the first quarter the book-to-bill in the Flow Control division was slightly over 1, let's say roughly flat. That's a good sign of things -- how things are stabilizing can improve over the period. Same thing in the Industrial segment, as it tends to be shorter cycle.

But if your -- if I'm answering your question right, a lot of the decline in our -- reflected in our guidance, is the project environment in 2014, the bidding activity in 2014 versus the bidding activity in 2015 and to a certain degree, the bidding activity we expected 2016 because some of goes through a percentage of completion.

Understood. Okay. Thank you. Second question is about the capital allocation policy. Last year, you were pretty comfortably over what you've mandated yourselves at. I was just kind of wondering, does that kind of normalize in 2016 or can you stay above that 40% to 45% return?

Well, right now we're -- we haven't changed our guidance in terms of the 40% to 50%. But as we talked about in terms of our capital allocation priorities, we always look internally and organic first. One of the things that we are very focused on is this restructuring, and that's where a lot of our cash will go to this year in terms of driving that.

So the priority is going to be our restructuring activities, our capital expenditures, which are anticipated to be more modest than last year but still important growth capital expenditures and then we're still sticking to our 40% to 50%. No change there.

I'm sorry; that's what it meant. (multiple speakers) 40% to 50%. It's just that you were so far above that last year and now, it will have to probably be tempered a little bit more because of some of the capital that has to go toward the restructuring; is that what you're saying?

Yes. We -- in the past couple of years, what we do is when we fund our internal initiatives and our priorities, we've over the last couple of years have returned the excess to our shareholders, which is very important. So to the extent were those are going to be more cash utilization on important internal initiatives, that the likelihood is that we'll stick to our guidance.

That's very good. Thanks. Nice quarter.

You're welcome. Thank you.

Chase Jacobson, William Blair.

Mark, I think you touched on it a little bit. I just want to make sure I understand this, but I think you said the gross margin was a little bit lower this quarter because of the bookings in 2014 and clearly, the pricing deteriorated throughout last year. So I guess the question is really, how long does the -- do those longer cycle projects take to flow through the income statement and is 60% decremental gross margin what we should be expecting as we go throughout the year and maybe into 2017 given how tough the pricing has been and the level of the OE bookings?

Well, let's say all other things being equal and they aren't because of the restructuring, but let's just start generally with the way to think about it. First, you look at the volumes. The volumes in 2015 in terms of project activity were lower than in 2014. The pricing environment in 2015 was more competitive than it was in 2014, not to the extent of what we saw in 2008 and 2009 because the pricing didn't get near those levels.

So those things flowed through -- started flowing through the P&L and last year and are reflective in our compares. So you'll have absorption, which you address with some of your restructuring activities, and also the pricing environment which you also address with your restructuring activities. But that's working its way through.

So the marginal impact, or the incremental impact starts to abate because you don't have as much project activity sitting in backlog. As we look forward, in terms of that -- the profile there, so we do need to get at the absorption issue. So the cost savings will focus on addressing the pricing environment, and also the volume environment that we're in.

And we're designing it to be very, very long term. The other thing then is you start looking at mix. If we start driving growth in the aftermarket business, start getting traction in the run rate business, then that can certainly support margins. Those are the levers and those are really the dynamics around our margin profile. But we've seen quite a bit of our project activity, certainly from 2014 go through the P&L and we're seeing 2015 now go through the P&L. There wasn't a lot of project activity at the end of last year, by the way.

Right. Right. Okay. And then Karyn, can you just clarify the accelerated SG&A expense of $13 million. Can you just talk about that again quickly and how much of that was in the guidance for the year?

Mainly, it's LTI, the acceleration, like I said, of non-cash accrual really relates to a change in our retirement plan. So accounting convention within a change and when we deploy, you have to actually pull that cause forward so really, it's essentially taking three years of cost and pulling it forward, s o you'll see a modest decline in our amortization of that over the next 36 months.

The majority of that sits in our corporate expense and then a portion of that is allocated down to the segments. In terms of guidance, probably about I want to say about 50% of that was considered in our guidance and then real accounting adjustments were made in first quarter.

Okay and this becomes a tailwind to next year; correct?

Slight; it's modest over the next three years in terms of reduction in amortization.

It takes -- what it does is it reduces its subsequent quarters. It takes three years to kind of get in the full cycle of this so we'll see this impact in Q1 but it will be less significant but as Karyn talked about, it is non-cash.

Okay. Thank you.

You're welcome.

Robert Barry, Susquehanna.

Wanted to circle back to IPD for a second. You had mentioned being particularly significant price pressured there; is that just really reflective of the segment's historically higher EPC exposure or is it the projects? Or is there some other dynamic going on there and is that accelerating recently or has that been kind of the state of affairs there for a few quarters now?

So Robert, I think you said IPD and we haven't seen -- okay, no, we haven't seen the big price pressure in IPD. What we did see was the reduction in oil and gas project activity. So IPD has some project that can actually be repurposed for other processes as well. But they were able to line it to the balance of the plant for some of these oil and gas larger projects.

What we saw was a decline in the bookings activity and these were -- these aren't huge but there could be $250,000 and above. We saw significant decline in that year over year. Offset by more penetration in some of our other industrial chemical applications and distribution. where we've seen the pricing competitiveness now for really about nine months to a year, is in the EPD segment; it's -- a lot of it is in the OE portion of that. Where we've seen the pricing impact; those are the big large projects, millions of dollar projects that are competitively bid.

Yes. That's what I was thinking actually and so when I saw in the release yesterday, there's mention that the project booking opportunities were challenged, competitively priced, particularly in IPD; it stood out for me but maybe it's competitively priced and so you're walking away from it and then that result for you is just lower bookings.

Right. I think the comment about project opportunity is competitively priced will apply to everything. But the fact is, we --it was more volume than anything else in IPD. Good questions on IPD; the point there is we have an opportunity to take the products that we have. We've got a good product portfolio, and much better to penetrate the market, is what happens when you get these large project activities; is that it will tend to tilt the entire organization to focus on those.

We've certainly -- we've made some changes, not only the leadership of IPD, but in our channel-to-market approach in terms of our sales organization, our distribution leadership to focus on this and we've seen some traction. So think of these -- think of those as we need to address markets better than we have before. And that's what we intend on doing.

As Mark has indicated, previously on the EPD side. On the IPD side, we also have had some project that we could have taken but for some of the terms and conditions which were extremely onerous.

Got you. Just -- thank you. That's helpful. One kind of big picture question; lots of discussion about moving capacity to low-cost countries, not just at Flowserve but elsewhere, too. So I was curious, as you look at the Company and across the industry, I mean to what extent do you think through this downturn and the restructuring and reaction to it were actually seeing a lot of capacity being, I guess simply moved versus actually removed or cut?

That's a good question. We're -- this what is much more removed than moved than we've seen in the past. Because we're -- what we're doing is closing facilities and consolidating that into some of our higher performing facilities, even in the OECD countries.

So there's a lot of closures relative to what we've seen before, but then again, what we'll do is we may move the product into a lead product facility, into a mature market and a lot of the work goes into a lower-cost facility in some of the emerging parts of the world. But this is really designed to position the Company long-term in the industry. Things we've been literally had on the drawing board now for 2.5 years, we just accelerated it.

Got you. Got you. Okay. I mean, it's clearly important, because as we think about pricing tightening through the next cycle it's obviously better if it's being removed than just being moved and the cost lowered. Okay, good. Would you say that the 15% to 20% reduction in workforce is kind of a good proxy for how much capacity you're taking out or do you have an estimate for that?

I think we've talked about a 30% of our physical capacity is getting taken out. So actually, there's more square footage in a sense then there is resources. And a lot of that is because we're building engineering and engineering centers in India to handle higher volumes.

What we're doing with the 30% take-out, what we don't want to do is not be able to address the markets when they become more robust. So I think the way to think of it is, even though we're taking the physical capacity out, I believe we'll be able to handle at or higher level of volumes than we been able to handle before. That's important; we want to be sure that we can address our markets because we still believe in the underlying secular drivers in the business.

Joe Giordano, Cowen and Company.

This is Tristan Margot for Joe today. Most of my questions have been answered but I was wondering, we've heard some of -- some operators wanting to opt for standardization instead of going forecast solar installations in their designs. How would that affect your EPD segment?

You're talking about going for standardization? Actually we work -- we welcome that. We work very closely with some of our large customers to drive that because what it helps us do, is to streamline our manufacturing process, our ability to support it from an aftermarket standpoint but more importantly, turn to our supply chain and drive the value through there.

Keep in mind, standardization does not mean commoditization. Standardization means we come -- we develop a common and expected set of process conditions, under which the equipment will operate. That actually helps us be more efficient.

It also helps us get more of a share of the customers' wallet as well because when you develop and can deliver the standards, it works well. I don't - - we don't look at that disfavorably at all; we actually encourage it in -- with our customers.

I would add, I mean, we've even gone as far as to put engineering talent in EPC facilities in order to drive that overall standardization strategy that they're -- that they've been embarking on over the last couple of years.

Nice. This is helpful, guys. That's all for me. Thank you.

Bhupender Bohra, Jefferies.

Question for Mark here. Mark, you talked about the FCD bookings, especially, you mentioned about the destocking at your distribution channels and kind of mentioned the word, restock, here. Can you give us a sense? I mean, your FCD, I believe, 40% of that business goes through distribution channel and just wanted to get a sense of what you're seeing there in terms of restock? Thank you.

We aren't seeing necessarily the restocking yet. What we talked about is we feel the destocking has abated and they're running just-in-time inventory. Now that's important, because for that channel to be able to be successful, you've got to be able to deliver in a timely and efficient manner.

And if you look at FCD's performance over the couple of years, the fact that it has the margin profile that it does is reflective of their ability to respond to all customers' needs, particularly our distribution channel. Now when I did make then comments is when we see some restocking occur that should be a tailwind for us but we have not seen that yet.

Okay, got it. And just to follow-on on the aftermarket activity, can you just go through geographically like how that looked in terms of project which is aftermarket?

Well, it -- geo -- what we've talked about is that the base aftermarket business has shown some stabilization. What we haven't seen that we saw in prior years were what we call the small aftermarket projects, some of the efficiency initiatives that some of our customers do. They're still holding onto that spend at this point in time but we're confident they'll do it because it actually improves the return on their operations but it's been pretty much stable what we've seen across the board in terms of all the operations globally.

Many of these projects that went in, in 2014 and the beginning of 2015 are now going into a period where they need spares during the first two years' worth of operation. So we are seeing some good activity relative to that in North America, Europe and Asia.

Obviously, Latin America is down given the whole political situation there so that looks -- I would say that looks promising. And we're also seeing in North America, because of the deferrals of the maintenance, we are seeing some emergency repairs start to kick in. Customers are coming in with very quick turnarounds so that business is now seeing a little bit different, I would say, driver in that business. And our EMA maintenance business in terms of upgrades on Flood Control. We mention desalinization and even the refineries are seeing some positive signs there.

Okay, got it. Thank you.

Thank you. And thank you ladies and gentlemen, we have reached the allotted time. Thank you for participating. This concludes today's conference. You may now disconnect.