Flowserve's CEO Discusses Q4 2011 Results - Earnings Call Transcript

Feb.23.12 | About: Flowserve Corporation (FLS)

Flowserve (NYSE:FLS)

Q4 2011 Earnings Call

February 23, 2012 11:00 am ET

Executives

Mike Mullin - Director of Investor Relations

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

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

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

Analysts

Hamzah Mazari - Crédit Suisse AG, Research Division

Robert Barry - UBS Investment Bank, Research Division

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

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

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

Jamie Sullivan - RBC Capital Markets, LLC, Research Division

William D. Bremer - Maxim Group LLC, Research Division

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

Jeffrey L. Beach - Stifel, Nicolaus & Co., Inc., Research Division

Operator

Good morning, my name is Christie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Quarter 4 2011 Earnings Conference Call. [Operator Instructions] Thank you. Mr. Mike Mullin, you may begin your conference.

Mike Mullin

Thank you, operator. Good morning, and welcome to Flowserve's Fourth Quarter 2011 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 this 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 of Flowserve; Tom Pajonas, our Chief Operating Officer; Mike Taff, our Chief Financial Officer; and Dick Guiltinan, our Chief Accounting 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 and 10-K filing and today's earnings presentation slide deck for Flowserve's Safe Harbor statement on this topic. All of 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.

Now I would 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 solid 2011 results, and I am proud of the work our employees have done to position us to take advantage of what we believe are improving end markets.

Looking at our 2011 financial results, bookings were $4.7 billion, up 10.2% versus the prior year. We ended 2011 with our highest fourth quarter backlog since 2008, in spite of geopolitical challenges and considerable currency headwinds.

Our aftermarket bookings grew 9% in 2011, demonstrating the success of our end-user strategies, which include ongoing investments in our global QRCs, as well as our strategic localization efforts. Earnings per share were $7.64, up 11% versus prior year. Our margins were negatively impacted by lower margin, large projects booked in 2010 and early 2011, as well as incremental costs associated with a few delayed shipments. Despite these margin headwinds, we had positive operating income improvement on both a year-over-year and sequential basis, as we continued to tightly manage cost.

Our 2011 results demonstrate the execution of our core strategies around global localization near key customers and resource allocations towards higher growth markets. Towards those strategies, we continued our efforts to reposition our people and capabilities in growing regions of the world, and we are seeing the benefits of these efforts in the bookings growth in emerging markets. We expect this trend to continue in 2012 in light of our additional investment in Brazil, China, India and Russia.

We also executed on our inorganic growth strategy in 2011 through the acquisition of Lawrence Pumps. In 2012, we will continue to seek out similar bolt-on opportunities, where we can purchase well-respected engineered technology that complements our product portfolio, has good brand recognition in an underserved market. We look for opportunities where we can leverage our global sales force and aftermarket platform to grow the business and pull through additional products.

Additionally, we recently set in place a new COO leadership structure, which will help us drive our One Flowserve initiative. We are seeing that increasingly our customers want to face one supplier. Our Shell frame agreements are a great example of that trend. Our new structure will help us leverage our product offering and aftermarket capabilities for our common customers across common markets and more quickly respond to the global trends we are seeing.

We will also drive expense leverage and common processes through our unified organization. Tom will give you more details on his plans around the new structure and where he sees opportunities for leverage and operational improvement. I would just point you to the success we have had in combining our pump and seal groups, as well as Tom's success in improving FCD's operational performance and margins over the last few years. We believe our more unified leadership structure will help us drive a strong culture of operational excellence through a common focus across the company.

Looking forward to 2012, we expect continued momentum in our short cycle and aftermarket businesses, and we expect the long cycle business to remain competitive, but slowly growing. We have seen some increased quoting activity around several large mega projects that have been announced or expected to be announced relatively soon. Although we are optimistic about these projects on the horizon, given the long cycle nature of this aspect of our business, we will not see an immediate impact on our results, as we must still produce lower margin, large projects in our backlog in 2012.

We expect the first half of 2012 earnings, particularly the first quarter, will be [indiscernible] compared to the first half of 2011, primarily due to the impacts of the delayed projects in backlog, the strong dollar and the continuing uncertainty in Europe. Mike will go into the guidance in greater detail later in the call.

Despite these headwinds, I believe we are well positioned with our increased backlog to continue to achieve our 5% to 7% revenue growth target for 2012. The guidance for revenue growth and margin expansion is based on our confidence in our end markets and our proven strategies around targeting growing global regions and markets to capture that growth.

With this increased confidence in our future, we recently announced a 12.5% increase in our quarterly dividend on an annualized basis. This action reflects our commitment to our policy of returning cash to shareholders.

In addition to focusing on profitably growing the business, we will always look to increase shareholder value and believe that along with our increased visibility and confidence, returning cash to shareholders was an important step in increasing our valuation. Simply put, while 2011 showed good progress, we believe 2012 is well positioned to be even stronger.

Before I turn it over to Mike, I'd like to thank Dick Guiltinan for all he has done for our company. It was a pleasure working with you, and we wish you the best in a well-deserved retirement. So with that, I'll turn it over to Mike.

Michael S. Taff

Thank you, Mark, and good morning, everyone. I am pleased to be here and serve as your new CFO. I'm excited about the opportunity we have to grow the company and create shareholder value.

Before I review our financial performance, I would like to thank Dick for the first-class financial team he has put in place and wish him the best in retirement.

Mark provided an overview of 2011. I am going to add some comments on the consolidated financials, talk a little bit about 2011 cash flow and how we have deployed our cash over the last few years and discuss our working capital performance and our plans for improving it.

On the financial results, we continue to see momentum in bookings with Q4 bookings growth of 11.3% over the prior year, while 4-year bookings grew at 10.2%, which, I would like to add, is the strongest bookings year we have posted since 2008. Our book-to-bill ratio in the fourth quarter was 0.9 on solid bookings and strong sales.

Our full year book-to-bill ratio was over 1.0 for the second year in a row at 1.03. Backlog at the end of 2011 was $2.7 billion, up 3.7% from the prior year.

Sales in the fourth quarter were up 11% over the prior year and up about 12% for 2011, reflecting the continued growth in the oil and gas and chemical industries and the full year impact of Valbart, which was acquired in July 2010.

Gross margin for 2011 was 33.6%, which decreased 140 basis points from 2010, in part due to a few large projects with low margins, along with some incremental charges on certain projects that have not shipped or shipped late.

As we turn to SG&A, you can see cost control continues to be a major focus, but not at the cost of limiting our investment in growing emerging regions. We continue to see the benefits of our realignment programs and cost reduction initiatives.

When you look at SG&A as a percentage of sales, the fourth quarter decreased by 130 basis points to 18.4%, while the full year of 2011 came in at 20.3%, which decreased 70 basis points from 2010.

Operating margin in the fourth quarter was 15.3%, reflecting strong leverage. Operating margin for the full year of 2011 was 13.7% or 14% when adjusted for realignment costs, which is down about 90 basis points from 2010 with the SG&A improvement partially offsetting the lower gross margin. Foreign currency rates continued to be volatile in 2011.

Other income expense net for the fourth quarter included $4.2 million in losses associated with transactions we have entered into in currencies other than our location's functional currency and mark-to-market charges on foreign currency hedge contracts during the period.

For the full year of 2011, we recognized a gain of $3.7 million. Our fourth quarter tax expense was negatively impacted by a profit mix shift to higher tax jurisdictions, resulting in a quarterly tax rate of 30.3%. We do not view this shift as permanent and expect our structural rate of 28% to 30% to remain intact going forward.

Turning to cash flows. We finished the year strong, as is typical with the seasonality of our cash flows. We generated $368 million in operating cash in Q4, bringing our full year cash flow from operations to $218 million. As we have mentioned throughout the year, working capital investment has been higher than expected. We'll take a more in-depth look at working capital in just a few minutes.

On investing activities, we had capital expenditures of $108 million for the year, as we continued to invest above our rate of depreciation. We also deployed $90 million of cash for the strategic acquisition of Lawrence Pumps.

On financing activities, we returned $220 million to our shareholders in 2011: $70 million in dividends and $150 million in share repurchases. So on a year-over-year basis, our cash balance decreased $220 million, as we finished the year with $337 million in cash with a net debt position of approximately 7% of total capital.

Turning to our use of cash [indiscernible], we have a historical look at how we have deployed capital over the last 6 years. We continue to take a balanced and disciplined approach to evaluating and deploying cash. We will provide some additional guidance around our expected use of cash in 2012 later in the presentation.

Turning to working capital. We saw sequential improvement in the fourth quarter, however, there is still work to be done. This is an area of focus for our team over the next several quarters. We made some progress reducing DSO to 75 days at year end. As I mentioned on our Analyst Day a couple of weeks ago, I believe we can drive DSO into the mid-60s. We also made some progress on inventory, shipping roughly 20% of our past due backlog, representing approximately $60 million. I believe there is another $60 million of opportunity within past due backlog, which we expect to get out the door in the first half of 2012.

Now I would like to turn it over to Tom, as he will talk about the markets and our divisional results. Tom?

Thomas L. Pajonas

Thanks, Mike, and good morning, everyone. Before I review the overall markets and the details of the business segments, I'd like to discuss the new structure.

As Mark mentioned, we are transitioning to a One Flowserve approach. We will be focusing on product and service platforms, as shown, and driving those platforms on a worldwide basis within our operating divisions of the Engineered Product Division, EPD; Industrial Product Division, IPD; and the Flow Control Division, FCD. Each platform will be responsible for product definition, manufacturing loadings, sourcing, lead and secondary product manufacturing strategy, sales and execution.

Several process functions, like financial systems, project management, supply chain, research, human resources and information technology will provide consistency of processes across the platforms. We're excited about this change, as we drive specific focus to each platform on a worldwide basis.

Overall, bookings increased from $4.2 billion to $4.7 billion year-over-year. Bookings grew nicely year-over-year by focusing on our aftermarket strategies and strategic growth initiatives in emerging markets. Opportunities continued to be mixed, with strong activity in most power markets, the chemical, general industries and upstream oil and gas. Aftermarket opportunities remain strong as we continue to redeploy resources and increase our capabilities through our services and solutions platforms.

Overall, the project business remained competitive. We continue to approach opportunities strategically by balancing pricing discipline, project win rates and market share targets, factory loading considerations and long-term business considerations. Large project pricing, however, remains very competitive in the current environment. In the oil and gas area, there's a shift of activity towards upstream production. In particular, natural gas has a growing focus, even as shale gas finds in North America have kept domestic prices low. Investments in new refineries continue to be driven by Saudi Arabia, China, Brazil and India. Oil and gas production spend could increase mainly because of the depletion rates of current fields and higher costs of developing new harder-to-find oil and gas deposits. While we expect long-term market growth to remain robust, we also see the near term being moderated due to economic uncertainty in Europe. As a result, we continue to view the immediate future as mixed, with opportunities continuing to present themselves in the emerging markets.

In power, activity is focused on China and India and particularly on the supercritical side driven by reduced emissions and efficiency. Nuclear power opportunities continue in various countries around the world, including the recently announced Vogtle plants in Georgia. Natural gas reserves have created opportunities for combined cycle power plants, particularly in the developed regions like the U.S. The chemical market in general is focused on the Middle East and China for new construction and MRO activity in North America and Europe. With recent finds of the shale of natural gas in the U.S., the use of natural gas as a feedstock has raised opportunities because of its low cost and available reserves. Refining, petrochemical and chemical plants will continue to vertically integrate. This is due to the proximity of the feedstock and the need of customers to drive more margin in countries like Saudi Arabia, the UAE, Kuwait and Russia.

General industries, including pulp and paper, mining and distribution, have seen a general increase over last year and have rebounded somewhat from the 2010 levels. Bookings in 2011 were dominated by the oil and gas industry of roughly 40%, with chemical at 18% and general industries at 22%.

Sales for 2011 remain roughly at the 2010 splits by region, with North America at 32%, followed by Europe at 23% and emerging markets at 45%. The Middle East continues with the refinery and petrochemical investments, even though there continues to be general unrest in some areas.

Asia Pacific continues to drive forward with investments in power, driven by the coal-based economies of China and India. Original equipment and aftermarket, bookings and sales saw good growth on a yearly basis. Original equipment bookings and sales grew 11.1% and 8.2%, respectively, year-over-year.

Aftermarket bookings and sales grew 9% and 17.6%, respectively, on a year-over-year basis comparison. The workforce of skilled engineers with our customers continues to retire at an accelerated rate. This should result in an increased reliance on suppliers, like Flowserve, and drive the demand for offerings like our integrated services and solutions.

Over the past 5 years, Flowserve has continued to make strategic investments in our most important resource, our people, specifically in engineering and leadership capability. Flowserve has added nearly 1,000 engineers over this period, representing a compounded annual resource growth rate of over 9%.

In addition, Flowserve has trained over 1,200 managers since 2008 in management and leadership foundation courses, with nearly 50% occurring in 2011, as we build our leadership bench for the future growth.

Flowserve has grown our employee resource base in emerging markets by over 50% since 2006, with 23% of all employees now located in emerging markets. Overall, we are excited about the infrastructure developments we see across the industries we serve.

Now let's review the various business segments in detail. The Engineered Product Division grew bookings 12.3% in Q4 versus prior year. Sales grew 13.8% over the same period. Bookings growth in Q4 came from the chemical, oil and gas power, and general industry businesses. Regionally, much of the bookings and sale growth in Q4 came from North America, Asia Pacific and Latin America.

Gross margin was 34.5% in Q4, down from prior year. Operating margins, however, were 18.7%, based on operating and income growth of 12.2% from prior year Q4. On a full year basis, bookings grew 4.1%, with solid growth in chemical, power and general industries.

Sales grew 7.8%, with regional growth in North America, the Middle East and Asia Pacific, followed to a lesser extent by Latin America. Operating margin was 17% for the full year in a mixed market environment. Aftermarket bookings and sales increased both in Q4 and the full year. Q4 bookings and sales increased 7% and 14%, respectively, and full year bookings and sales increased 9% and 16%, respectively.

Our aftermarket business continues to strengthen. Services and solution opportunities also continue to grow, gaining interest from our customers by focusing on energy efficiency and operating cost reduction.

Overall, Flowserve has 450 global customer alliances, of which approximately 112 are fee based. The power market, in general, saw good growth on a yearly basis, in spite of the continuing effects of the Fukushima incident.

Projects in fossil, gas, solar, geothermal, wind and biofuels are proceeding and present opportunities for bookings growth. The chemical market again saw good growth, especially with the opportunities that gas presents itself as a feedstock versus liquids.

Oil and gas opportunities continue to present themselves, particularly in the Middle East. Proposal activity has been robust in this area, even though the oil and gas business was down about 2.5% from prior year.

Overall growth in general industries, including mining and paper, provide for good diversification of our product base. In the face of competitive pricing environment, we continue to focus our lower cost sourcing, cost management and productivity improvement using our well-established continuous improvement programs.

We also positioned ourselves for growth by taking advantage of emerging markets. We invested in more strategic localization efforts in Brazil, India, China and Russia, and we continued to differentiate our integrated solution offerings through expanded asset management contract offerings. We completed our acquisition of Lawrence Pumps and integrated it into the business in Q4.

Lawrence is a premium brand name in the oil and gas and chemical sectors. Their products are well known for their reliability in harsh, critical service applications. This acquisition is consistent with our strategy to grow and deliver value through bolt-on additions. Lawrence Pumps is now part of the EPD portfolio.

The Industrial Product Division, IPD, is improving, with increased bookings and sales in Q4 versus prior year. Orders were up 5.3% in Q4 versus prior year, thanks to the increases in chemical, power and water business.

Regionally, that growth came from North America, Europe and Asia. Sales were up 14.3% in the quarter based on North America and Asia Pacific projects. Operating margin was 9.1% for the quarter, as we continue to work off lower margins in the backlog from prior periods.

We are also continuing to work on increasing the performance and efficiency levels of our IPD plants. On a yearly basis, bookings grew by 9.4% on the strength of the chemical and general industry business. Regionally, the growth came from a strong Asia Pacific and Europe and, to a lesser extent, North America.

Sales grew 9.7% on a year-over-year basis with strong growth coming from North America, Asia Pacific and Latin America. Operating margins for the year were 7.2%. We continue to optimize certain structural parts of our business, including an increased emphasis on on-time delivery and overall unit efficiencies.

Both bookings and sales grew in the aftermarket business for the quarter and full year. Aftermarket bookings in the quarter and the full year grew 18% and 9%, respectively, while sales grew 14% and 17%, respectively.

IPD will continue to stay focused on improving operational efficiencies, on-time delivery and overall contract execution. IPD remains committed to reaching its operating margin target of 14% to 15% by 2015.

The Flow Control Division had a solid quarter of performance. Bookings were up 15.2% versus Q4 with strong growth across all sectors, including chemical, oil and gas, power and general industries.

Regional booking growth was strong in North America, Europe, Asia Pacific and Latin America. Q4 revenues were up 5.6% versus prior period, with strong growth coming from the Middle East, Asia Pacific and Latin America.

Gross margins of Q4 were up 180 basis points versus prior period, based on stronger showings in the oil and gas businesses. Operating income increased 18.3% versus prior year Q4. The overall book-to-bill ratio was 1.0 for the quarter, while the book-to-bill ratio on a yearly basis was 1.09. On-time delivery to our customers was 91%.

For the full year, bookings increased 22.7% over prior year based on the growth in the oil and gas, chemical and general industries. Sales increased 23% versus prior year. Latin America and the Middle East lead the increase, coupled with strong percentage increases in Europe, Asia Pacific and North America. Operating income increased almost 29.3% versus prior year. Aftermarket bookings and sales for the full year versus the prior year increased 7% and 23%, respectively.

In addition, all customer channels to the market, original equipment manufacturers, engineering and procurement and construction, end-users and distribution, grew in bookings year-over-year. Overall bookings growth reflected our investments in emerging markets, particularly in the Middle East and Asia Pacific, along with the strength in our core developed markets. In our industrial markets, the chemical industry continued to see strong Q4 growth, driven by smaller capacity increases and MRO activity.

Renewed interest in chemical plants is beginning to form in the Middle East based on their drive to be recognized as a petrochemical hub. This is also the case in the U.S. based on the abundance of relatively low priced shale gas. Germany and key markets in Asia reported strong MRO activity. We also secured new orders for the silicon chip production for the solar business.

In the oil and gas business, we have seen continued interest in the LNG market, particularly in Australia, and some interest in the U.S. Gulf Coast region, again, based on the abundance of shale gas. Proposal activity remained strong with the gas projects, LNG projects, pipeline initiatives and Middle East activity. Shifts from gas to liquid in the U.S. have been a continued topic in the North American market. The power market has not yet stabilized. This is due to the nuclear reports due out of China, the continued discussion of the fossil coal EPA requirements in the U.S., and the overall inquiry and the interest on combined cycle plants.

Solar projects continue being discussed, along with renewed interest in biomass projects, albeit on a smaller scale. In general industries, pulp and paper in South America continued to drive forward, as well as the overall distributor business. The distributor business increased over 22% year-over-year, as this relative market continued to gain strength. Some project orders were also realized in the steel industry for air separation plants and in other industrial gas applications in China.

FCD's key initiatives will continue to drive our aftermarket and original equipment penetration into the emerging markets, particularly in China, Latin America, the Middle East and Russia. Our focus on on-time delivery and quality will provide FCD with customer growth platforms for the future.

And now I'd like to turn this back to Mike Taff.

Michael S. Taff

Thanks, Tom. So let's take a look at 2012. We will continue to be disciplined in our approach to capital deployment, as we work to balance and align our growth initiatives with our desire to return capital to shareholders.

Yesterday, we announced a 12.5% increase in our quarterly dividend to $0.36 a share, which is the fifth year in a row we have increased our dividend. We expect CapEx to be between $120 million and $130 million in 2012, as we continue to grow the business and support our customers. We expect pension contributions of $20 million to $25 million and have required debt principal payments of $25 million. We outlined our revenue targets a few weeks ago and expect to see a 5% to 7% growth in 2012, excluding the impact of potential acquisitions. Moving to our 2012

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quarter of 2012 is expected to be impacted by some low margin, late project shipments booked in 2010 and early 2011 and a reduced level of aftermarket shipments compared to the fourth quarter of 2011.

Earnings will be further impacted by the effects of the stronger dollar. We expect negative translation effects, given the average euro rate of roughly 1.4 in the first half of 2011 versus the 1.3 we have seen so far this year.

In addition to the translation effects last year we saw from a weaker dollar, we also expect the $0.11 gain from a transaction standpoint we saw in the first quarter of 2011 not to recur. Finally, we are reaffirming our 2012 full year guidance of $8 to $8.80 per share, including $0.50 of negative foreign currency impact. And now I'll turn the call back over to Mike.

Mike Mullin

Thanks, Mike.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Hamzah Mazari.

Hamzah Mazari - Crédit Suisse AG, Research Division

The first question is just around working capital. Maybe if you could just comment on what levers you're focused on. I know your targets out there on working capital, Mike, you mentioned them. But maybe if you could just talk about what structural challenges you may face in improving that working capital, given some of the factors inherent in your business.

Mark A. Blinn

Okay. Well, why don't I turn it over to Tom and then to Mike to, kind of, walk you through it, one from an operational and the other one just, kind of, from a financial targeting.

Thomas L. Pajonas

Yes, so, Hamzah, what I would say on the working capital from an operation perspective, I mean, what we're going to concentrate on is on-time delivery, obviously, documentation and the closure of that documentation towards the back end of the contracts. We're going to look at lead times because, obviously, that can help also on the working capital as we now deploy more lean into the businesses. And then, basically, getting through the units in a high efficiency, the throughput overall in the businesses. Those would be the 3 or 4 operational things that I would concentrate on. Mike?

Michael S. Taff

Yes, I agree exactly with what Tom said. And also, we'll obviously address it on the front end, too, as we go through the bidding process of looking at certain things. So it's really a 2-phased approach. One is addressing on the front end as we go onto new orders; and then second, is putting some procedures in, as Tom mentioned, operationally in what's in place today. As far as metrics to look for, I think we ended the quarter at 75 days DSO. We're going to drive that down into the 60s, that's our goal. It's about $13 million to $14 million for every day we reduce that. So I think there's a good $100 million out there of monetization on the AR side. On the past due backlog, we mentioned we reduced that by 20%. We think we've got at least another 20% to go, and that would be a monetization of another $60 million to $70 million. So we've got work to do. But it's in our sights, and we've done it before, and we just got to get busy and focus on that over the next several quarters.

Mark A. Blinn

And Hamzah, I'll just add, structurally you asked, if you look at this industry back '07 and '08, very strong pricing environment, and we use the term that people were basically putting cash forward for manufacturing slots. So you were able to command more cash at that period of time, and that's the one dynamic, as you've seen, is just gotten more competitive and the capacity we've talked about, the ability just to command that market in general, us and our competitors, has decreased. I think the other thing is, when we talked about this, is when -- as you move more to emerging markets, high-quality customers on the end, but they do tend to pay slower. So I think those are some of the structural issues that we've seen overall in our industry. But I think the message for you is, as we talk through these concepts of working through the cycle, as we talked about, and that working through this past due backlog and some of the opportunities Tom has around operations, that all fits, and the output of all of that is working capital.

Hamzah Mazari - Crédit Suisse AG, Research Division

Very helpful. And just a follow-up question. As you look at your current product portfolio, are there any product gaps right now that you need to address, either organically or acquisitively? And maybe if you could also comment on your thinking around whether -- what your views are on the frac pump market. I know you're not in that market right now, but do you find any other markets attractive right now that you're not in? And maybe also just on the product gap side, if you have any, going forward.

Mark A. Blinn

Well, a lot of questions, and this is really the subject of a lot of our strategic discussions, and I'll try to encapsulate it shortly here. I mean, I think when you look at our product gaps, we addressed one opportunistically with Lawrence Pumps. We've developed the first phase of our chemical pump in the IPD business, which was introduced. We need to bring the next generations to market. Because on the ANSI standard, which is the American standard, we have the leading product equipment. We need to develop more for the ISO standard. So I think there are opportunities. Now I don't think there's a product that we look at that we said is going to fundamentally negatively impact our business if we don't have. It's more around opportunity. Now when you look at the mining industry or the frac pumps, those are strong markets right now. And you can't be all things to all people. You've got to look at how you get selectively into those markets, consider that they do go through cycles, they're in strong cycles right now, and penetrate it as you can.

Think about it, though, when something is really hot to go get it in organically, you're going to pay quite a bit for it. I mean, the market is not going to give it away for free. So I think -- that's how we think about these opportunities. We have the opportunity to develop some incremental capabilities internally in the Mining business. We have a good competitor in that area. They're very good at what they do. But we always feel the market likes competition, and so we seek opportunities to get in there as appropriate. But again, you take a step back. When you look at inorganic, what we want to do is be able to leverage our existing sales and aftermarket platform and be able to realize that return for our company and our shareholders over a reasonable period of time in terms of internal rates of return. So that's how we're going to think about it. And we'll keep approaching our product offering. We're very detailed in terms of how we look at it. But I think one of the things with all the products that we have, we have a lot of technology, a lot of capabilities that we can adapt to different markets. A good example is some of the equipment that we've adapted for the tar sands would not have been thought of 10 years ago, 10, 15 years ago, but that has good penetration up in Canada at this point in time.

Operator

Our next question comes from the line of Robert Barry.

Robert Barry - UBS Investment Bank, Research Division

A couple of things. One is on IPD. And I was wondering if Tom could just comment on what he's thinking about for that business. And maybe it's still kind of early days, but that path to 14% to 15%, I mean, is that going to be kind of back-end loaded? Is there some low-hanging fruit that we could see, kind of, progress in the next 12 months and then kind of move gradually there? I mean, how should we think about that target because it seems like there's still some pretty significant operational challenges in that business?

Thomas L. Pajonas

Yes, I mean, I would say there are some operational things that we have to take a look at. But the 14% to 15% is achievable over the next 2 to 3 years. If you look at our coming out of the gate here in terms of 2011, we had good orders, good sales. So I would say the front end of the business is beginning to work well. Again, we have opportunities on on-time delivery. We have opportunities on the quality side of the business. Certainly, the working capital. I've mentioned before in terms of the low-cost sourcing, this business is shorter terms, similar to the Flow Control Division where there's significantly more low-cost sourcing around the world in FCD than there is in IPD. So that's an area that we can begin to get some additional margin out of. Certainly some of the things like lean and manufacturing optimization we'll begin to target. And I would also say the supply chain, in general, will be an area that we'll provide a lot of focus on certainly in 2012.

Robert Barry - UBS Investment Bank, Research Division

And then you made a comment in the prepared remarks about Europe. I was wondering if you could talk about whether since you gave the outlook back in December, is Europe tracking, kind of, weak as expected or is it weaker or stronger?

Mark A. Blinn

It's pretty much along the lines as expected, Robert. We saw that -- if you look at our bookings, EMA was the one that really -- that was negatively impacted last year. And we've seen kind of a similar approach this year. The real question is, as you take a step back is, I think there's consensus that they're going to go into recession. The question is how long and how deep? And I think a lot of that hinges on how quickly they can take action to basically firewall their credit-related issues and to get an accord amongst the countries as to how they're going to proceed going forward. You've seen some improvement there, but really until there's a firm understanding of how they're going to move forward, you wouldn't see, necessarily, the impact overall in our business.

Thomas L. Pajonas

And I would add, I mean, Europe on a year-over-year basis was only about 2% off. And on a quarter-to-quarter basis, it was essentially neutral.

Michael S. Taff

The only thing I'd add there, Robert, is obviously -- we talk about -- a lot about our exposure to the euro and the quantum of the dollars. But that's not just strictly business that stays in Europe. That's business we're doing with customers where our contracts are valued in the euro but actually the products go outside the country to other places.

Robert Barry - UBS Investment Bank, Research Division

Yes. And then just finally on EPD. I look at the backlog there exiting the year into '12. It's about the same as what it was going into 2011. I know the bookings started to accelerate in this quarter, but it’s probably more of a 2013 impact on the P&L. I mean, you think the revenue will grow in EPD this year?

Mark A. Blinn

Robert, I don't want to give guidance beyond what we've given you. But the 5% to 7% range kind of helps you understand how it will grow across a couple of them. What you saw in EPD was -- coming into the year, it was still, as we talked about, choppy and competitive. So you focus in these engineered areas on loading your factories, absorption, also around price. But what we talked about in the middle part of the year was we saw some stabilization and increased selectivity. It was that selectivity in effect that kind of kept it flat, if not slightly down on the OE side year-over-year, but we continued to drive the aftermarket business. This is kind of how you manage these big long cycle engineered facilities and opportunities, as you move out of a cycle. So as we look forward, what we do have to do, and it's in EPD and IPD and a little bit in FCD, is clear the past due backlog that's been around for a period of time. And that's for a number of reasons. It could be supply base, some of the issues that we've had or really some of these projects just haven't come online as originally scheduled, and customers weren't anxious to take the equipment. But that will start to clear in the first half of this year. We'll work through that. A lot of that is in EPD, and we move forward. But I think, as you look at revenue this year, we will remain selective and drive the aftermarket business overall. And as I mentioned in my comments, we do see some of these project opportunities coming back over the horizon. And with that, we think pricing will ultimately follow.

Michael S. Taff

But, Robert, as we said in our prepared comments, we do feel good about the revenue projection and trajectory on in the 5%, 7% growth on a consolidated basis.

Operator

Our next question comes from the line of Charlie Brady.

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

Just a couple of quick ones, verifications. On the tax rate first half, you're expecting -- would you expect the tax rate in Q1, Q2 to be above that 28% to 30% range?

Michael S. Taff

Yes, you said 28% to 30%. I think, overall, Charlie, I think what you'd say is that, we feel good on an annual basis that our structural rate will remain in that 28% to 30% range. Quarter-to-quarter, it's going to bounce around. There's a lot of things that drive that, whether it's revenue mix, profit mix and things like that. But on any other basis, we still feel comfortable that our structure rate being in that 28% to 30% range.

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

Okay. It's not fair then to say that the first half might be a little heavily weighted towards a higher tax rate just because of the mix of shipments going out the door?

Michael S. Taff

Yes, I mean, it's certainly -- it could be. It's just -- a lot just depends on where that's coming from and all that. So it's hard to project quarter to quarter. And I think we really look at our tax rate more on an annualized basis versus a quarterly basis.

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

Okay. And did you quantify realignment costs for IPD in '12?

Mark A. Blinn

No, we didn't, specifically. I mean, we're -- it's relatively small. We're pretty much through all that. We'll have some residual realignment cost, a couple of million dollars.

Michael S. Taff

Yes, I think most of it is going to be more of larger, just paying some bills and cash flows versus [indiscernible] at this point.

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

Okay. And then one more, just -- I want to look at the U.S. nuclear market maybe a little more closely and the opportunity there, because you had Southern Company come out and get approval for the first 2, to build first 2 reactors in over 30 years. You've had the NRC come out the past few days proposing new safety regs in the U.S. You've got the Nuclear Energy Institute out there saying that nuke companies are buying a lot of equipment. Can you maybe give us a sense of what you view the opportunity in the U.S. is over the next 2, 3 years on the nuke side?

Mark A. Blinn

Let me just respond with the high level theme, and I'll turn it over to Tom. I mean, I think this is what we've been talking about for a while. Nuclear power represents 20% of the power supply globally. And if anybody thinks they're going to diversify away from it over a short period of time, that's just not the case. You can see it in certain isolated areas where they've moved away from it in countries, but in general, this is a viable, long-term, well-established supply of power globally. And that's what we try to say as we -- you can see the short-term impacts of some of these things, but the U.S. is a great example. It's a key source of power. They don't have alternative ready supplies, alternative power and emerging powers. Those aren't going to replace these base standards of power over the short term. So it's a high level theme to think globally as it relates to our business.

Thomas L. Pajonas

And I would add to that, though Charlie, that if you look at the U.S., there's 104 reactors in the U.S. A lot of them are coming up for relicensing, so that's going to present opportunities for us over the next several years. The aftermarket parts and services has continued to be robust over this time period because many of these plants are plants that were built in the '70s. And like you mentioned, Vogtle got its construction and operating license just a few days ago, and we participated in that particular project. And that commercial operation is coming up in 2016, 2017 for those plants. And then you also have SCANA, which has not gotten its COL yet, but that supposedly is coming up for review here shortly. And that's a plant that's similar to the Vogtle plant in South Carolina, 2 plants for that. And those also have a 2016, 2019 commercial operation date. So I think we’re going to see a mixture of some new plant constructions, aftermarket and relicensing going on, as we go forward here over the next several years.

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

When you guys get orders for nuke work, is it come out of EPD or Flow Control or is it rather evenly split?

Mark A. Blinn

Well, we have -- I mean, if you were to look at the Vogtle and SCANA without getting into the actual details, I mean, it was pretty equally split. Valves participates on both of those plants. Also, the EPD group participates on those plants on the pump side. Obviously, on the seal side, they go along with that. So we have both opportunities. And I think I've mentioned before, a typical plant could be anywhere from $60 million to $80 million on a typical nuclear plant, not including the aftermarket over the next 30 years.

Operator

Our next question comes from the line of Scott Graham.

Mark A. Blinn

Yes.

Thomas L. Pajonas

Yes, and what I would say is this. Certainly, I mean, the FCD business has performed well over the last several years, but we have a very capable person in there that's been part of the succession planning for the last 4 years. And I hope and expect, based on the objectives that he's been given, that he's going to take that business to the next level as it goes after emerging markets and gross margin and those type of things. A lot of my emphasis, because I have -- there is a, I would say, a different base in FCD right now, a lot of my emphasis will be on the pump side of the business. We've talked about IPD in the past, and we have a road to go to get that up to 14% or 15%. But I think the road largely is in our internal responsibility to get there. I think the market is there for those products. We need to get better on the on-time delivery, pretty basic. We need to get excellent on the quality, which is what our customers expect that those products get out there and are tested and pass testing the first time and get out to field and work with no subsequent revisions. So we -- I feel pretty good that we got a view of what needs to be done. Now it's the amount of backlog that has to come through, and it's the length of the projects that will determine, ultimately, how that margin begins to develop over the next several months.

Mark A. Blinn

Let me add a couple of things to both of those. One is, Tom has a -- and all of them has, really, a good group of people in there. So one important message is as we look at this opportunity, and yes, Tom is busy, he's always busy, but he's got some really good folks to help him out. And I think that's important to understand as well. And of course, and I made this point in the Investor Day, we all have a tremendous amount of confidence in Tom and his team. And so I think -- I just want to make sure that's very clear here as we look forward. And then, Scott, just again on your currency issue. I mean, it was against the full year. If you look at the currency benefit we got, it was rather small for the full year. But a good way to look at it is there's above-the-line and below-the-line impact. And look, if a dollar strengthens 10% against all of our foreign currencies, we have a disclosure in our K. And if you think about 70% of our businesses in those foreign currencies, that's a 7% hit right there on -- as it kind of flows through. So what's important -- a lot of people get focused on our below-the-line, but the currency hits us above and below the line. It's part of being predominantly an international business.

Operator

Our next question comes from the line of Mike Halloran.

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

So could you talk a little bit about the price competition you're seeing on the engineered pumps versus the IPD segment? Are you seeing more competition on the pricing side and the more standardized IPD products versus the engineered products at this point, or is it pretty broad-based?

Mark A. Blinn

Well, the big -- we've talked about this before. The big large projects that you see out there are still competitive. Because if you look at our industry and the capacity, which is getting incrementally utilized, but that's one of the best and most efficient ways, efficient in terms of you can get it, get it to that capacity, getting that capacity utilized overall in the industry. It's the heritage of our industry. It's the old iron concept of our business overall. It's these big, big projects. And so they're fairly -- they are competitive at this point in time. When you look at FCD and IPD, those can -- it's probably not as broad based. You may have pricing competition in certain areas. But you tend to have more pricing power quicker because of the short cycle nature of the business.

Operator

Your next question comes from the line of Kevin Maczka.

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

I wanted to ask a question about these lower margin shipments coming out of backlog. That's been kind of a key theme for a number of quarters now. And a few quarters ago, we were talking about lower margin business and backlog that was booked at less favorable pricing during the downturn. And now we're talking about past due backlog, which is more related to either a customer delay or an execution issue or what have you. So I guess the question is, are we done with the low margin business that was booked during the downturn? And are we now just focused on kind of cleaning up our own execution or customer delays and working on past due current backlog?

Mark A. Blinn

Well, there’s still both. And some of them are both. And what I mean is some of the ones that were booked years ago that they haven’t taken delivery on or are late in delivery, those were projects that were competitively priced and haven't gotten any better in terms of their margin profile. And then you have the projects that were booked in '10 or '11 that are not due to be shipped yet that are still coming through in a more price competitive environment. And then you have some projects that were booked early part of last year, which have run delayed more shorter cycle mainly in IPD, which have been delayed in cost. The general theme is the longer -- and ENCs [ph] know this, customers know this. This is why lead time is so important. The longer a project stays in the plant, the more costs attach to it. So it's really a combination of the things. But in general, the market-driven impact, what you heard from us in the summer was selectivity and stabilization in these bigger projects. That will take whatever the lead time is, but typically, a year-plus. So the market-driven aspect, you can start to see clear towards the latter half of this year. The past due typically comes at the end of a cycle. Those are the ones that are late. We're going to -- we talked about -- we really started talking about those on the third quarter call. We expected to get those out over the next couple of quarters. Fourth quarter, first and second quarter is primarily where we'll get most of that moved out. So those are the 2 forces that are driving it.

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

Right. And you said you moved out $60 million in Q4, and you're planning to do another $60 million in the first half. But I thought I heard a 20% number on the call today. Can you explain what the 20% is? Is $60 million only 20% -- or is that 20% of this past due backlog?

Michael S. Taff

Yes, that's correct. I mean, we’re always going to have some past due backlog. And we measure that as a term of our efficiency and on-time delivery and all. And when you have the multitude of projects and the size of business we have, we're going to have some of that. What's happened over the last several quarters is that's gone up probably about up to about $120 million, $130 million. So what we mentioned is that we've shipped about $60 million of that in Q4. We've got about $60 million additional to get down to kind of our normalized past due backlog, which we measure as a percent of backlog, and generally, kind of best in class is in that 5% to 7% range.

Mark A. Blinn

So with historically, there's always an element of past due backlog, but a couple of things about it. It's not necessarily all low margin past due backlog. If you look back in '08, '09, that was not the case. We had past due backlog. You will always have it for certain reasons. Because what we do is we're very rigorous to measuring to the contractual date. Even though the customer may have asked you to extend it for a period of time, it becomes past due backlog. So we want to keep the metric very, very pure so -- what Mike was talking about. But keep in mind, stuff moved in and out of past due backlog in the fourth quarter.

Michael S. Taff

But in quantum, that balance reduced 20%. And again, we think we've got another 20% to go to kind of get it below that $200 million mark.

Operator

Your next question comes from the line of Jamie Sullivan.

Jamie Sullivan - RBC Capital Markets, LLC, Research Division

So just a follow-up to the last question on the past due backlog. Is the right way to think about that the past due backlog that's shipped in the fourth quarter and scheduled for the first half, that's the most material impact, for instance, on margins? And once you get that, you're sort of back to, kind of, a normalized level of where the past due usually runs?

Mark A. Blinn

Well, that's what we anticipate. What Mike talked about is as we move into the back half of the year, we'll get to more normalized levels. And our expectation is Tom, over time, will drive those normalized levels to new lower levels. So we don't -- we're not satisfied. We're just going back to where we were before. But I think, just a couple of things to think about. Past due backlog that is late, that is, comes from a competitive pricing environment is low or no margin type of backlog that goes through. So I think that's the distinction I want to make is we could have -- we had past due backlog coming out of the last strong cycle, and it still had good margin in it. So I don't ever want to associate past due backlog across the board is 0 or small margin business. But in this instance, what we have is backlog that came out of a competitive environment and that has been delayed. And those 2 things will compound to a low margin backlog. That's probably the best way to think about it.

Jamie Sullivan - RBC Capital Markets, LLC, Research Division

Right, that's helpful. And then maybe just on IPD. One of the trends this year, there was price pressure like in some of the other businesses, as well as some higher material costs. Just wondering how that feels now on the pricing side, whether some of that pressure is relieving and how you feel your, kind of, price cost on the material side is balanced as we go into 2012.

Mark A. Blinn

Yes, I mean, I do think if you look at '11, I mean, there was some pricing pressure due to the competitiveness that lingered around there. We did have some, maybe some slightly negative or neutral material. I think we're probably going to see the material maybe take a slight upswing, but that's some of the forecasts that have been out there. I would say, on the short cycle business, we've been indicating that seems to be have been rebounding through 2011. And I would consider the short cycle business to continue maybe with that trend going forward; a little bit different than the longer cycle business where we’ve mentioned that we still have some of that price competitiveness.

Michael S. Taff

And as I looked at Tom's opportunities, the market-driven price we talked about. But I also see that Tom's going to be able to get more pricing powers as he continues to improve the execution because that's one of the primary determinants of price in the short cycle business. You've seen it in FCD. This is why we talked about -- look at FCD to see what the opportunity can be in IPD, is he drives cycle times down. And matters of that, he's going to get pricing power.

Operator

Our next question comes from the line of William Bremer.

William D. Bremer - Maxim Group LLC, Research Division

Let's stay with the FCD for a minute, very nice growth year-over-year. Looking pretty much at the sales for the fourth quarter was up less than 6%. And the bookings, especially on the aftermarket there, were down 10% in the fourth quarter. Is this just sort of like a timing issue that you called out in your release? Or is there something more here that needs to be focused on?

Mark A. Blinn

Taking a step back, looking at the year, I mean, a big contributor to what you saw on the bookings and sales was the acquisition. So I think this is why we're excited about the Valbart acquisition. They grew the business, they were able to grow the operating earnings, and it was right along our strategy. It was a product that we needed, that we had the platform to deliver, and FCD did it and did it very well. When you typically look at it, and you can look over a couple of years, you've seen, oftentimes, Q3 can be stronger than Q4. I think the most important point on this, I can say, is we've said we're not a quarter-to-quarter business. Don't look for a trend overall in FCD or in anything else unless we call it out on a quarter-over-quarter basis. They had a great year.

Operator

Your next question comes from the line of David Rose.

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

Two follow-up questions. One is, if you can comment a little bit about some of the operating initiatives on Lawrence Pumps? And anything that you've seen on the upside or negative in terms of surprises? And then lastly, if you can comment on section 316(b) of the Clean Water Act, if you've seen any project activity relating to that?

Mark A. Blinn

Well, I'm going to defer on the 316(b) to somebody else in the room because I don't know what it is. But I can comment generally on Lawrence Pumps. As you take a step back, it was a good operation, functioning very well, great product. We've been very pleased with that acquisition so far. So we haven't broken it out specifically or anything because we've really integrated it into our business, overall. But we're thrilled with that acquisition.

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

How have you started to leverage the sales force? I mean, I guess that's what I wanted to get a better handle of is, where are you getting the leverage or where you expect to see the leverage?

Mark A. Blinn

Well, if you think about it, if you look at us versus a lot of our competitors, we have a very broad product offering. And that's important for, we think, a concept around balance of plant. You look at some of these big facilities, and Lawrence Pumps is a critical service piece of equipment. So now our sales force, after we train them, and they've known about the product, many of them have coveted it for many years, is they take a step back. Now they have another arrow in their quiver when they go in and talk about an opportunity, be it an original equipment, greenfield opportunity, a brownfield upgrade and repair or, more important, on the aftermarket side. Now they have another product that they can take care of, another product that -- to bring into their portfolio. So what we do with that is, it went from a Massachusetts-based with some sales agents around the world to, all a sudden, it had over, close to 1,000 people that were immediately trained in the product and were capable of selling -- capable in selling it, understood it. And they understood it before. They were well aware of the product. So that's what the opportunity is on the sales side. And now, if you've been to one of our QRCs, I mean, it is capable of servicing, repairing, upgrading one of these Lawrence Pumps. So now all of a sudden, as opposed to the piece of equipment being served by a local agent, which is oftentimes the case, our sales person there says, "Look, we'll take this and that and this other piece of equipment to our QRC and take care of it."

Operator

Our next question comes from the line of Jeff Beach.

Jeffrey L. Beach - Stifel, Nicolaus & Co., Inc., Research Division

I have a question about aftermarket. Are there any new drivers to sustain this, I'll say, give or take, double-digit, low-double digit growth that you see emerging here in 2012 into 2013? For example, outsourcing, is it showing some accelerating trends? And is there anything else that would, kind of, drive and sustain this good growth?

Mark A. Blinn

Well, I think it's more around market positioning and opportunity. As we talked about in the Investor Day, the external market growth was certainly moderated for this year and stronger in subsequent years. But I think it's really riding on some of the momentum that we've been talking about up to this point. I can go through a couple of them. FCD's further penetration in the oil and gas industry. A couple of years ago, they were heavily concentrated towards the chemical side. They have now a strong and increasingly stronger position on the oil and gas side as well. It's pushing technologies out. It's getting in front of more customers on the aftermarket side. So it's really more of the same in light of some of the challenges that you see out there around Europe and other regions.

Thomas L. Pajonas

And I would add to what Mark indicated that our coverage in all areas around the world currently isn't the same. So for instance, great opportunities in China and Latin America right now for aftermarket coverage, same thing in Russia. So as we start developing those areas along with the Middle East, that will give us opportunities. We see a lot of clients continuing to move towards, I would say, total cost of ownership in their overall strategic plan, as they look at managing their assets, which get us into now more fee-based LCA arrangements with them. So that's also a good opportunity. And I would also say, as you see the oil and gas business, the power business go to more critical applications, higher pressures, higher temperatures that also brings that aspect into it requiring more maintenance or more governance on the overall plants.

Operator

There are no further questions at this time.

Mike Mullin

Thank you, operator, and thank you all for joining.

Operator

This concludes today's conference call. You may now disconnect.

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