Flowserve Earnings Call INSIGHTS: Fertilizer Production Opportunity, Legacy Backlog

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

Fertilizer Production Opportunity

Charles Brady – BMO Capital Markets: If we go back to the commentary on the strength in this (indiscernible) feed activity. Can you get some more granularity on where you are seeing that by end market geography?

A Closer Look: Flowserve Earnings Cheat Sheet>>

Mark A. Blinn – President and CEO: We talked a little bit about softness in the Middle East and that’s mainly around the projects that we see on the horizon, some refineries that are being built that we see coming on next year. So, you are seeing a lot of the feed work in that area. Feed work in the LNG, so if you look at particularly a lot of the western E&Cs they’ve been doing a tremendous amount of feed work. There is front end work being done on the chemical particularly in North America where you are seeing gas as a low cost feedstock and then also we talked a little bit about the power industry year-over-year and really for the quarter down it was kind of mixed. We have actually seen nuclear start to free up a little bit and we are seeing that combined cycle on the horizon, but solar has been challenged and they are still working their way through the coal-fired, but as we look over the horizon, certainly some combined cycle opportunities and we think that nuclear is going to come back online. So, that’s consistent with what you have seen. Also in the mining industry you’ve seen continued feed work, that’s been the case for about the last two years.

Charles Brady – BMO Capital Markets: Your commentary on fertilizer production opportunity. Can you just go into that a little bit more. It’s an area I don’t think you’ve talked a lot previously?

Thomas L. Pajonas – SVP and COO: I mean, as Mark was indicating, the amount of pre-feed and feed work is significantly up on a general industry’s segment of which a lot of that is the fertilizer business on a worldwide basis. So that business looks like it’s really driving pretty heavily across many different regions around the world, and we would expect some good bookings going forward in that business. Charlie, consistent with the trends we’ve been talking about for a while, demand; demand for food, demand for water, demand for power, demand for hydrocarbons they will vary from time-to-time. I think one consistent theme that we’ve talked about, as you’ve seen the impact to Europe and we are not the only Company, but pretty much across the board in our sectors, we have seen the impact of what’s going on in Europe.

Charles Brady – BMO Capital Markets: One more, I’ll get back in the queue here. What is the new share count assumption embedded in the current guidance for 2012?

Michael S. Taff – SVP and CFO: Charlie, it’s Mike. I think the best way to think about is, for the year we purchased about $433 million worth of shares and by year-end we’d expect that number to increase another $200 million or say, $240 million or so by the end of the year.

Legacy Backlog

Scott Graham – Jefferies & Company: I was just wondering, maybe this is a question for Mike and one for Tom and (truthfully) Mark, one for you. Mike, the cash flow profile of the Company has improved towards a two consecutive quarters now, I know that there’s a lot of blocking and tackling work, but is there also an aftermarket element to this where maybe the conversion of cash that cycle is expedited a little bit, and gives you a little bit more visibility on what your liquidity looks like going forward?

Mark A. Blinn – President and CEO: This is Mark. It works a little bit the other way, particularly in our seal business, because we keep a lot of parts and spares in our QRCs so that we can respond very quickly. The aftermarket, if you look at our aftermarket business, the key is the ability to be able to respond very quickly. So what you’re seeing in the improvement, a lot of it is focus, there’s a lot of focus, but the other thing, as Mike commented, at the beginning of the year we talked about our focus around our past due backlog, which is distinct from legacy and how we were going to bring that down and we’ve had good success, that will correlate to working capital, the utilization of working capital. So it’s really been around a lot of the operational improvements, we still have work to do on the working capital, but that’s driven some of the cash conversion.

Scott Graham – Jefferies & Company: As far, so Mark, may be they’ll just stay with you. The legacy backlog, just – I guess it’s frustrating from an outsider standpoint that this thing just keeps slipping into heaper and heaper quarters, now you are signaling that possible even into the fourth quarter, could you tell us why that is exactly?

Mark A. Blinn – President and CEO: This is the same thing, it is the other side of what we saw in 2009 and 2010, when the 2008 very high priced backlog lived with us for a period of time, that’s just the way our long cycle business works. We commented last year that some of the projects we are going to live into 2012, I think the key is you’ve seen the growth in our aftermarket business have been able to offset that, the growth in our short cycle business it’s way our business works and it is also why you didn’t see tremendous volatility in earnings through the cycle because you have this lag effect. So, as Mike commented, I mean, one of the particular projects we are very – it is very strategic, we are very happy about it (saw sourced) in the Western region of Saudi Arabia will get the kind of aftermarket capture that you are now seeing embedded in our $508 million of bookings but the fact is these things you work through on their long cycle project. So, we anticipated it will work through them, sometimes these things do push if the customer is not ready but for the most part we’ll have a lot of this cleared from where we were at the beginning of the year at the end of the third quarter and the fourth quarter we typically have a lot of other strengths in our business that will tend to offset that. As we set up for 2013 we will get the benefit from really moving out of the cycle that we saw in 2010, 2011. We talked about some of the additional bidding activity that we see in 2013 and some projects, we will see some of the benefit from that next year but it will carry on that will be long cycle as well, so that benefit will stay with us. Driving our initiatives, as we talked about around an improvement in our gross margins, improvement in our operating margins focused on leverage. So, this is the way we kind of cycle through in our business.

Scott Graham – Jefferies & Company: So, let me just try to paraphrase what you said on the incremental. So, what we thought was going to be kind of a wrap-up in the third quarter of the legacy shipments essentially gets pushed into the fourth quarter based on customer pushbacks of deliveries, is that fair?

Mark A. Blinn – President and CEO: You can have the customers. Look, one of the things on these big projects we talked about before is we have to wait on a motor and if the motors slow on delivery then that can push us, but for the most part, we see our way through, where we were at the beginning of year, we see a lot of this getting out by the third quarter which is what we anticipated. If some carries over to the fourth quarter that can happen overall in our business, but we’ll move past the cycle this year and basically get into the environment we’ve been since the last half of 2011, starting in 2013.

Scott Graham – Jefferies & Company: Other question I had was for Tom. Tom, your work across the segments and just kind of wondering, I asked this quarter last quarter, but now we’ve got a little bit more run way here with you with what you are doing little bit more time to implement. What are the big things that you are focusing on the cost side right now, Tom?

Thomas L. Pajonas – SVP and COO: I mean everything from our perspective starts on the proposal space, so we are putting a lot of effort into the proposal and in terms of the set up of the scope on the job, the set up of the terms, the costing, a lot more advanced procurement resources we put on that aspect. As well as good cash flow management as we look at our cash flow strategies in the proposal phase. So I’d say that’s one aspect. We continue to focus on the same things that we’ve been focusing on in the last several years, which are gross margin. There we take a lot of effort in terms of low cost sourcing, the lean, the Six Sigma efforts, the throughput through the facilities. We have good line of sight on areas that we want to fix in several of our facilities and we have teams on those. I would say the other two items are items we talked about before, which is the base which is the on-time delivery. So a significant amount of focus on supplier on-time, as well as individual unit on-time delivery with our initiatives. We spend a lot of time on quality and quality of documentation to get at the working capital as well as try to get at first-pass yields through the business, so that we improved the overall efficiency and throughput through the businesses. So I would say, a lot of the basics we continue to drive we just have, I would say, a more rigorous program for driving those initiatives.

Mark A. Blinn – President and CEO: Scott, the general theme that was in our comments and what we are focused on. We are very focused on what we have in our four walls and being able to even drive margin improvement there. We think we have opportunity there. If you think about it we came through a high price cycle in ‘07 and ‘08. We spent a lot of time realigning what I’d call the front-end of our business in ‘09, ‘10, and ‘11, on the aftermarket side, integrating pumps and seals and now this is a step around really driving the operations engine of this business to carry us into this next cycle.