Flowserve Executive Earnings Call Insights: End Market, Margin Pressure

On Tuesday, Flowserve Corporation (NYSE:FLS) reported its first quarter earnings and discussed the following topics in its earnings conference call. Take a look.

End Market

Jamie Sullivan – RBC Capital Markets: Question; overall it sounds – you sound incrementally positive on your end market, particularly long cycle in chemical. Is there anything that you’re bit more cautious on based on what you see?

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

A Closer Look: Flowserve Earnings Cheat Sheet>>

Jamie Sullivan – RBC Capital Markets: And then in the general industries area, I know that’s a diverse end market for you. The booking sounded stronger at EPD, maybe a little bit softer in some of the other segments. Just wondering if you can talk about what’s driving the differences there?

Mark A. Blinn – President and CEO: Well I guess in the general industry keep in mind, you’ve got mining, pulp and paper, some of the aspects of that and we saw some improvement overall in the mining business, but also you have some of our orders that goes through distributors that are in that segment. So what you do see is distributors start to stock again in their inventory levels. You will see the benefit of that in the GI side.

Jamie Sullivan – RBC Capital Markets: And that’s what you’re seeing?

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

Jamie Sullivan – RBC Capital Markets: Great, then one last quick one on oil and gas. So outside of the positive long-terms fundamentals you’re seeing, what maybe over the next year or so what areas do you see the most activity occurring?

Thomas L. Pajonas – SVP and COO: Jamie, this is Tom. One of the good areas or bright spots is the LNG market and as we mentioned because of the shale gas prices in U.S. you could see the LNG become an exporter out of the U.S., so that’s a significant bright spot. Also the Canadian (power sands) activities has remained high for us given the overall price of oil, so that is also doing well and the Brazilian offshore is another growth area for us.

Margin Pressure

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

Michael S. Taff – SVP and CFO: Robert, it’s Mike. We’ve estimated that they’re somewhere between 150 basis points to 200 basis points for the quarter and I think you’ll see similar effect in Q2 and then some will run on into Q3 as well.

Robert Barry – UBS: That 150 basis points to 200 basis points that’s both for EPD and IPD?

Michael S. Taff – SVP and CFO: Yeah, majority of that was EPD, but yeah that’s a consolidated number.

Robert Barry – UBS: Then as we get into the back half of the year, should we expect things to kind of snap back once those two projects move out, or is it going to be more of a gradual improvement?

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

Robert Barry – UBS: Okay, and then I just wanted to differentiate between the low-margin backlog and the past dues, and I believe some of it is interrelated, but I think, Mike, you had alluded to something even slipping into 3Q, and just to be clear, is the low margin – the few low margin projects, are they kind of moving through as planned and (indiscernible) after 2Q, and is the past dues that you think might linger into 3Q, or – I just wanted to be clear on that?

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

Michael S. Taff – SVP and CFO: Yeah. I mean – I think, Robert, there is certainly some consistency there and one and the same. I mean – because you can have some legacy backlog, and when we’re referring to these legacy backlogs, these were really – the projects were booked in the downturn at much lower gross margins. They maybe on schedule; they may be part of the past due backlog. When we’re referring to past due backlog, it’s really more of working capital concern as well as margin concern. Because as you know, when a project reaches the past due backlog phase, then you start getting into some additional costs such as liquidate damages and things like that.

Robert Barry – UBS: Just one housekeeping item. Is it possible to just break out the revenue and bookings impact from Lawrence in the quarter?

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