Flowserve Management Discusses Q2 2012 Results - Earnings Call Transcript

Flowserve (FLS)

Q2 2012 Earnings Call

July 31, 2012 11:00 am ET

Executives

Mike Mullin - Director of Investor Relations

Mark A. Blinn - Chief Executive Officer, President and Director

Thomas L. Pajonas - Chief Operating Officer and Senior Vice President

Michael S. Taff - Chief Financial Officer and Senior Vice President

Analysts

Charles D. Brady - BMO Capital Markets U.S.

R. Scott Graham - Jefferies & Company, Inc., Research Division

Kevin R. Maczka - BB&T Capital Markets, Research Division

Michael Halloran - Robert W. Baird & Co. Incorporated, Research Division

Robert Barry - UBS Investment Bank, Research Division

Hamzah Mazari - Crédit Suisse AG, Research Division

William D. Bremer - Maxim Group LLC, Research Division

Jamie Sullivan - RBC Capital Markets, LLC, Research Division

Brian Konigsberg - Vertical Research Partners Inc.

John R. Moore - CL King & Associates, Inc.

David L. Rose - Wedbush Securities Inc., Research Division

Stewart Scharf - S&P Equity Research

Presentation

Operator

Welcome to the Flowserve Q2 2012 Earnings Conference Call. My name is Kim, and I will be your operator for today's call. [Operator Instructions] I will now turn the call over to Mr. Mike Mullin. Mr. Mullin, you may begin.

Mike Mullin

Thank you, operator. Good morning, and welcome to Flowserve's Second Quarter 2012 Earnings Conference Call. Today's call is being webcast with our earnings presentation via our website at flowserve.com. Simply click on the Investor Relations tab to access the webcast and the accompanying presentation. The webcast will be posted at flowserve.com for replay approximately 2 hours following the end of the call. The replay will stay on the site for on-demand review over the next several months.

Joining us today are Mark Blinn, President and CEO; Tom Pajonas, Chief Operating Officer; and Mike Taff, Chief Financial Officer. Following our commentary today, we will begin the Q&A session.

Regarding any forward-looking statements, I refer you to yesterday's earnings release, 10-Q filing and today's presentation slide deck for Flowserve's Safe Harbor statement on this topic. All this information can be found at Flowserve's website under the Investor Relations section. We encourage you to read these statements carefully with respect to our conference call this morning.

And now I'd like to turn it over to Mark to begin the formal presentation. Mark?

Mark A. Blinn

Thank you, Mike, and good morning, everyone. I am pleased with our second quarter results. The progress we have made operationally, as well as the strategic actions we have taken, are positioning our business to capitalize on the continued global trend towards infrastructure spending, which will enable us to continue to grow and drive shareholder value. I am very proud of our employees' constant focus on serving our customers, while we make these operational enhancements.

In spite of what appears to be another summer of uncertainty with the European debt crisis, the looming U.S. fiscal cliff and concerns over the rate of economic growth in China, we remain optimistic about the prospects for our end markets and our ability to capture profitable growth across our diversified markets.

I'm also very pleased with the improved quality backlog resulting from our disciplined effort around pricing and selectivity, as well as the leverage resulting from focused cost control actions across our operations and at corporate. The SG&A line, in particular, highlights the flexibility and operating leverage of our business.

While work remained, Tom and his leadership team continue to gain traction in their efforts to drive operational excellence through our One Flowserve initiatives. They were able to increase sales, operational and cost leverage across many of the common processes in our business units. We are seeing tangible progress across many of our initiatives, including cost of quality, on-time delivery, supply chain, working capital, cost management and the front-end bidding process. The benefits of these initiatives are starting to show in our results and are improving the quality of our backlog.

As we discussed after the first quarter, we anticipated challenges in our gross margins in the second quarter as we made progress shipping low margin, legacy backlog, which was taken in the competitive environment of 2010 and early 2011 as the groundwork for our aftermarket business.

We've also seen a continuation of the dollar strengthening since the end of the first quarter and expect additional earnings headwind as a result. Mike will outline the expected impacts from legacy backlog and currency for the rest of the year when he updates you on our current guidance.

Turning to our capital structure, we took additional actions in the quarter to increase the efficiency of our balance sheet and ultimately increase value for our shareholders. Based on our consistent performance through the cycle over the last few years and the demonstrated cash generation ability of the business, coupled with our improved visibility and our strength in end markets, we concluded it made sense the increase the efficiency of the balance sheet and capture the value that additional leverage would provide to our capital structure.

Our board approved the targeted capital structure with a gross debt Level of 1x to 2x EBITDA, compared to our prior gross debt level of 0.7x. We decided that the best use of the cash generated from this higher leverage was to increase our share repurchase authorization to $1 billion.

We intend to complete this share repurchase program during 2013. We also initiated a $300 million accelerated share repurchase program under this $1 billion authorization, financed with short-term borrowings to systematically repurchase shares and to more quickly bring our debt level into our new targeted range of 1x to 2x EBITDA. We are very pleased that all 3 rating agencies recently upgraded our debt rating to investment grade upon our announcement of this new capital structure strategy. We are now well-positioned to take advantage of the current attractive debt markets as we progress towards our targeted capital structure.

Moving to the second quarter financial highlights, I'm pleased with our 12.5% earnings improvement over last year, particularly in light of significant above and below-the-line currency headwinds of approximately $0.38. Second quarter bookings were solid, as we continue to capitalize on our investments in our end-user strategies and localization, resulting in strong aftermarket bookings in the quarter of $508 million.

Our focused and disciplined investments through the downturn have enabled us to create a current $2 billion annual run rate aftermarket franchise. We don't take this opportunity for granted and recognize that every day, we must earn the right to support our customers.

The second quarter also highlighted the strength of our diversified regional exposure. Weakness in Europe and softness in the Middle East were more than offset by strength in North America and Asia Pacific. We have seen this theme play out before. Our diverse regional and end market exposures, together with our strong aftermarket franchise, provide the company with a lower net risk profile, which we believe is a key differentiator.

Looking forward to the balance of 2012, we are keeping a close eye on Europe. However, I continue to be cautiously optimistic about how the cycle is progressing. Quoting activity has been above 2011 levels. And while uncertainty in Europe caused the timing of some projects to shift, this increased activity should result in increased booking opportunities in 2013 and beyond.

While we are optimistic about these future large infrastructure projects and our aftermarket potential, we will continue to focus on areas where we have greater control, including operational initiatives, driving our end-user aftermarket strategies and the pursuit of small cap run rate projects, while we wait for the large projects to work their way through the approval process.

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