福斯 (FLS) 2008 Q3 法說會逐字稿

Good morning. My name is Christy and I will be your conference operator today. At this time, I would like to welcome everybody to the Flowserve third quarter 2008 earnings conference call. (OPERATOR INSTRUCTIONS) Thank you. I will now turn today's conference over to Mr. Zac Nagle, Vice President of Investor Relations. Mr. Nagle, you may begin your conference.

Thank you, Operator. Good morning, everyone, and thank you for joining us. Welcome to Flowserve's third quarter 2008 investor conference call. Today's conference call is also being webcast along with our earnings presentation on our website at flowserve.com Just click on the investor relations tab to access the webcast and the accompanying presentation.

Before we get started with the presentation, I'd like to highlight a couple of important items. First, we scheduled the duration of the call for a full 90 minutes. While we typically have to not needed that much time, we're happy to go beyond our typical hour to cover prepared commentary and any subsequent Q&A. Second, for those of you who have accessed today's call through our dial-in phone number and also wish to follow along with the earnings presentation slides on our website, please select the "click here to listen via phone" icon on the event details page. I'd also like to note that our webcast will be posted on our website for replay approximately two hours following the end of the call. The replay will stay on the site on demand for the next few months.

Joining today are Lou Kling, President and CEO Flowserve; Senior Vice President and Chief Financial Officer in Latin America Operations, Mark Blinn; and Vice President and Chief Accounting Officer, Dick Guiltinan. Following our commentary, we'll being the Q&A session. Regarding to any forward-looking statements, I'll refer you to yesterday's earnings release and 10-Q filing and today's earnings presentation slide deck for Flowserve's Safe Harbor statement on this topic. All this information can be found on the Flowserve website under the investor relations section. I encourage you to read these statements carefully with respect to our conference call this morning. The information in this conference call, including the initial statements by management plus their answers to questions related to projections or other forward-looking statements, are subject to Flowserve's Safe Harbor. Now I'd like the turn things over to Lou to begin the formal presentation.

Thanks, Zac, and good morning. It is a pleasure to welcome you to our 2008 third quarter conference call. I'm pleased to report that the third quarter was another terrific quarter for Flowserve with continued strong execution and outstanding financial results. These record results again demonstrated the improving operational excellence, continued strength in our end markets, strong leverage in our income statement and the successful execution of our key strategies. This resulted in strong organic growth in bookings and sales for both our original equipment and after market portions of our business as well as solid year-over-year gross margin and operating margin improvement.

When looking at the year-to-date, our strong financial results through the third quarter have increased our confidence in our ability to continue to deliver strong earnings and cash flow in the fourth quarter. As a result, even with the adverse impact from the strengthening dollar, we expect our full year earnings per share to be at our around the high end around our previously announced range of $7.20 to $7.50 per share. It is also worth noting that a long-term benefit of a stronger dollar also improves the competitiveness of our non-US operations which represents approximately 70% of our global business.

During the next few slides I will touch on some of the significant Company highlights for both the third quarter and year-to-date as well as the primary performance metrics achieved during this quarter. Equally important to the reported financial results are what we're seeing in the major markets we participate in, oil and gas, power, chemical and water. I will spend a considerable amount of time on this topic since I know its on the minds of our many of investors. We will also look at some commentary about our target global markets from numerous external sources, including some of our major customers to demonstrates that our positive outlook doesn't just represent an isolated Flowserve point of view, but rather a hot of views that point to what appears to be continuing opportunities for products and services despite the generally uncertainty about the overall macroeconomic outlook.

In light of the unprecedented shifts in the credit and financial markets, I will share some history with you with respect to our markets during the past 13 years as they went from similar cycles from an economic point of view, and then I will review with you what we have been doing during the past few years to improve the Company's performance and to prepare for any business cycle since history tells us even in weak cycles, our markets may temporarily decrease but they don't go away. This discussion will provide you a better understanding of our external market outlook and help you gain a stronger sense of opportunities we see ahead.

I also want you to know that to date we haven't seen any meaningful reduction of opportunities and, in fact, the proposal pipeline in all divisions is still extremely strong. In addition, we have also not seen any unusual cancellations of projects around the globe, but we'll continue to monitor this very carefully and respond quickly to any changes in market conditions as needed.

Slide three covers some notable highlights in the third quarter 2008. We delivered record fully diluted quarterly earnings per share of $2.04 up over 85% versus the same period last year. Earnings per share during the quarter also benefited from tax items detailed in our 10-Q and press release of approximately $0.22 which was partially offset by foreign currency hedging activities of $0.12 in the quarter. This significant increase in earnings reflects continued success in driving improved consolidated operating margins increasing 240 basis points to 14.2%. This also reflects both continued gross margin improvement year-over-year of 100 basis points to 35.1% and a further reduction of 170 basis points in SG&A expense as a percentage of sales to 21.2%.

We also delivered our second consecutive quarter of bookings in excess of $1 billion, recording bookings of nearly $1.4 billion, up almost 30% over the previous year, including organic bookings growth of 22%. This was led by the pump division delivering an impressive 44.3% growth in bookings in the quarter, including over 35% organic growth. We continue to drive strong manufacturing throughput in the third quarter, delivering record third quarter sales of almost $1.2 billion, up nearly 26% over the previous year, including over 18% organic sales growth.

Based on our strong global footprint and portfolio of industry leading products combined with our strong sales force we achieved significant growth in both our original equipment and after-market business. Even during the growing financial crisis of September, we were able to renew and increase our unsecured European letter of credit facility from EUR80 million to EUR100 million reflecting our bank's strong confidence in financial position. Reflecting our continued commitment to return value to our shareholders and in confidence and cash flows, we repurchased approximately $100 million during Flowserve shares during the quarter.

Additionally, on September 26, based on the strength of our balance sheet, we had our corporate credit rating increased by Standard & Poor's BB with a positive outlook from BB minus with a positive outlook. Just a few hours later we were added to the S&P 500 added index.

Slide five covers the key year-to-date highlights for 2008. The team delivered record earnings per share of $5.71 in the first three quarters, up over 104% versus the same period last year. Bookings for the first three quarters reached a record $4.1 billion up over 28% versus a year ago including almost 19% organic growth year-over-year. Sales to the third quarter were also up sharply versus 2007 reaching a record $3.3 billion up nearly 25% including almost 15% organic growth this year.

In addition, at the close of the third quarter our backlog stood at a healthy $3.1 billion, showing a solid support for 2009 revenue and earnings. And, in fact, we have also been taking orders for 2010 delivery such as the Abu Dhabi crude oil pipeline order received last month.

Gross margins have steadily improved through the first three quarters, up 220 basis points to 35.4% based on strong operational improvement, a solid pricing environment, and improved fixed cost absorption on higher sales while SG&A cost control has also continued to show (inaudible) progress, decreasing an additional 140 basis points to 22.1% as a percent of sales. Consolidated operating margin has continued to benefit from the team's success in driving effective initiatives to improve both gross margin and SG&A as a percentage of sales, increasing sharply by 340 basis points to 13.7% versus the first three quarters of 2007. So as you can see, our financial performance for the first three quarters of this year far surpass our previous year on all significant financial metrics. The third quarter also demonstrated that good business opportunities remain in the market and we continue to use our strong global footprint and after-market strategy to win this new business. By continuing to solidly execute on these contracts, we will be well-positioned to keep delivering strong operational and financial results to our shareholders.

Slide six outlines in traditional P&L format the third quarter highlights I discussed on the previous slides. Since I fit most of these key financial highlights previously I won't go into any further detail here. Moving on the slide seven, which I'm sure is familiar to many of you, you can see the quarterly progression of bookings since 2004 and a tremendous growth we've driven since the back half of 2005.

Slide eight highlights our sales since the beginning of 2004 and the average conversion cycle we have talked about many times between a booking and a sale, which has averaged about 12 months. I would like to remind everyone again that this is an average conversion cycle with valves and seals normally being shorter than 12 months and pumps, on the average, being longer.

Now let's take a look at what drives infrastructure opportunities. Over the past decade, infrastructure spending was primarily driven by profit. Much of the work around the world was managed by western multi-national corporations with a need to create shareholder value. Today, several additional factors increasingly drive the need to invest capital for infrastructure needs. These drivers include demographics, aging infrastructure, independence and economic growth. Within each of these areas are a number of motivating factors such as population movement from rural to urban cities, refurbishment needs, energy security, and potential political stability to name a few. In many cases these investments are supported by more than one of these factors and in the developing markets many are supported by government funding or guarantees not directly related to today's US or European capital markets.

Slide 11 begins to look at our core infrastructure markets, oil, gas, power, chemical and water from the point of view of numerous external sources, including some of our major customers. In the oil and gas market, which represents about 37% of our market to date, we continue to see our global customers making investment decisions based on projected demand growth, upgrade and optimization projects, refurbishment of aging infrastructure and economic growth in developing regions. It is important to understand that these major investment decisions by our customers are not made based on the spot price of oil but rather on longer term product demand considerations.

We have all heard the news lately that projections for demand growth in this market have softened from the beginning of the year. And as of a week ago the Energy Information Administration and the International Energy Agency, the two energy watch dogs for the United States and Europe, did forecast a reduction in demand for oil. But that global demand was still up approximately 400,000 barrels per day for 2008 and a projected 700,000 barrels per day for 2009.

In addition, as you can see, we received positive announcements in the chart, news in the market continues to show planned investments over the long term as demonstrated by companies such as Exxon Mobil, Conoco-Phillips and the major oil companies of India, China and Saudi Arabia. This news aligns with the overall general feedback we are receiving directly from our customers which includes the recent concerns raised about the Canadian tar sands projects. From what we're hearing from our customers this does not appear to have any effect on the current projects but may have an effect on projects in the planning phase. Since these tar sand projects represent less than 2.5% of our bookings year to date, it should have little effect on our future results.

Slide 12 illustrates a view of the global business opportunities for Flowserve based on the long-term view of oil demand. Fundamentally, there is some level of opportunity for Flowserve across a full spectrum of prices for a barrel of oil. However, there is also an optimal range where investments are made across all aspects of the industry. As we have discussed in the past, many of our heritage brands have earned strong customer preference over the years within a downstream portion of the oil business. When oil prices float in the optimal range, the crack spreads remain healthy which allows the downstream owners, particularly the refineries, to invest in the optimization of their facilities which includes capacity increases, refurbishment, and modernization and fits well within our product offerings.

Recently, with the declining availability of light [Swede] crude oil it has become imperative that refineries convert their current operations in order to handle the heavy order coming into the market where we have the right product technology to support them. Midstream or pipeline investments are made with oil prices within or above the optimal range as shown by our recent announcement of our Abu Dhabi crude oil pipeline contract of approximately $85 million to $90 million.

As oil prices move outside the optimal range, additional investments may become feasible. For example, when the prices are in or above the range, we benefit from the increased investment in both the development of alternative fuels and complex oil recovery systems. When oil prices are in or below the optimal range, the consuming industry, such as chemical, power, and what we classify as general industries, enjoy lower operating costs and higher margins which drive investments and optimization and expansion which ultimately creates excellent business opportunities for our products and services in those target markets.

The challenge occurs when oil gets the too low or too high. When it is too low, consumers expect prices to fall which leads to lower margins and lower profits for refineries, thereby restricting investment in new facilities. When oil gets too high, the market reacts by reducing demand. The problem for all of us is there is no absolute numbers defining the boundaries for optimum oil pricing. Each type of oil produced has different cost structures which form the basis for their optimal high and low spread. For example, typical production costs for light Swede crude relatively close to the surface run under $10 per barrel. These production costs increase significantly as you move through the different grades of oil and production methodologies such as heavy crude, Canadian tar sands crude and subsea crude.

As we discussed earlier, it is important to remember that major infrastructure investments are not made on the spot price of oil. These are long lead projects that are based on the projected requirement for oil usage, usually years away, where independent research data still shows an increased demand for oil. In addition, national oil companies which own over 90% of the world's oil reserves invest in oil development for many reasons other than profit, such as social programs, demographics, aging infrastructure, security, independence and economic growth.

In the power industry, which represents about 15% of our business to date, the need for basic electricity continues to drive the industry forecast of significant global growth for the next several years. This need is created by growth in urban years, aging infrastructure, new environmental standards, expansion of industrialization of developing regions and the moderation of urban areas such as the more than $300 billion planned for development in mid East for city development. Over the past couple of months China has announced plans to add 60 gigawatts of power to their nuclear grid by 2020. This was, in fact, incremental to their plans for coal fired and natural gas fired generating units.

Announcements have also recently come out relative to the critical needs for additional power in India. It was recently reported that the Indian government has allocated $95 billion to meet the increase in demand for power across the country and has revised their target for incremental power generation over the next five years from 79 gigawatts to 90 gigawatts. The world energy output report for 2007 projected that energy demand would double by 2030 from a baseline in 2005 and, to our best knowledge, this projection has not been modified to date.

In the chemical industry, which represents about 19% of our business year to date, there continues to be a focus on investment in to lower cost regions in the world as well as in developing alternatives for petroleum-based products. The move in to low cost developing regions has continued to drive growth in new plant construction in both Asia and the Middle East.

As you can see in the recent announcements, regions in China are planning major capital spends for chemical facilities such as the investment plan of $15.8 billion by China Guodian. Many of the major companies in China are continuing with their plans to build refinery and petro chemical complexes over the next several years. As for alternatives to petroleum based products, there continues to be investments in the development of biotechnology alternatives as well as fuel alternatives. A significant amount of attention is also being given to coal gasification investments supported by recent announcements stating that in 2009 there are construction plans of $8.9 billion in North America alone.

In the water market, which represents about 6% of our business year-to-date, the available market tends to stay steady in an upward direction. This is supported by the persistent need for water worldwide, the continuing need to refurbish aging infrastructure and the requirement to bring older operations up to current standards. The need for water globally is challenging the available fresh water supplies and is driving an increased need for the expansion of desalination and the resource for portable water. With the advancements in technology for seawater reverse osmosis, the cost of desalination has dropped significantly, making it much more as a viable alternative. Desalination market segments is projected to grow more than $56 billion in the next seven years.

A report from Morgan Stanley earlier this year looked into the projected water needs of the emerging economies and determined that the infrastructure requirements to meet these needs could drive an increased amount of spending from its current estimate of $80 billion annually to $180 billion annually over the next 15 to 20 years. Along with the emerging market requirements, a June 2008 report estimated the infrastructure upgrades in the United States alone would require $700 billion in capital investments. As urban city centers grow, industrialization and modernization projects to commission and as population increases, the need for portable water and water for industrial purposes will also grow. This growth will continue to challenge the industry to find ways to produce and deliver this water to its point of consumption.

As we have discussed over the past several slides, the market in our core industry still presents significant opportunities for growth. When you look at the available market for pumps, valves and seals for the past 13 years in all our markets, you can see the impact of tougher economic times. What is most interesting is that the infrastructure markets, both mature and developing, continue to provide business opportunities throughout the various parts of the cycle. So we'll continue to plan for this market fluctuation and their potential cycle while pursuing activities to increase market share and strengthen customer relationships.

I believe the title of this chart "Be Prepared" is indicative of how we run our business. As a company, we are continuing to focus on key strategic initiatives to enhance our ability to take advantage of market opportunities no matter what part of the economic cycle we are in. As I have said many times, operational excellence is a key strategic area of focus for our management team. We are continuing to look for areas which strengthen our current performance as well as position us to manage through any cycle.

Some of the areas we have made great strides in include moving manufacturing engineering and material sourcing to low cost regions of the world, utilizing multiple ships instead of adding brick and mortar, utilizing flexible staffing where practical, adding advanced computerized machine capabilities to reduce manufacturing time, reduce labor burden and improve quality and many other cost-containment initiatives. We have also continued to strengthen our ability to share and leverage knowledge through the integration of our global ERP systems, development and implementation of a global engineering platform and the establishment of global engineering centers. Combine these initiatives with our key growth strategies help position the Company well for all phases of the business cycle.

Slide 18 gives a high level view of the investments we have made over the past few years to strengthen our global diversification and competitiveness around the world. As you can see, we have significantly expanded our capabilities in four key regions, China, India, the Middle East, and Latin America. Our approach has been to establish indigenous operations to effectively serve the local market while taking advantage of low cost manufacturing, competent engineering, and strategic sourcing where practical. These position us well to support our global customers from project inception through commissioning and over the life of their operations.

As you look at slide 19, you can see the range in diversity of our recent global project wins. We have been successful across all our markets and regions around the globe as our customers continue to demonstrate long-term trust in Flowserve as a dependable business partner.

Slide 20 gives an overview of Flowserve's after-market growth strategy. The chart on the left represents our after-market revenues for the third quarter of 2008 and, as you can see, highlights significant growth in revenues since 2006. We believe that this growth is a direct result of our end user strategy which focuses on creating greater value for our customers through expanded after-market services. By maintaining proximity to our customers through the use of over 150 quick response centers worldwide working with our customers to optimize their equipment operation both Flowserve and competitive products as well as training their people and minimizing their down time, we can develop long-term relationships that provide continued business opportunities. This after-market growth strategy is truly one of the aspects of Flowserve that makes us different and along with our global diversification, positions us to continue to win business through all phases of the business cycle.

Slide 21 shows a selection of strategic technologies where we have made significant investments to meet the current and future needs of our customers. And because many of these projects are being conducted in conjunction with our customers, many are actually funded or cofounded by these customers. Our investments in nuclear capability and desalination are providing current business opportunities as well as helping to support future growth. Teaming with a major oil producer, we have made significant developments in pumping systems for deep water or sub sea production operations. We believe this experience is placing us on the leading edge of technology development in this crucial future market. In the area of advanced electronic diagnostics, we have developed both intelligent pumping systems and intelligent valve systems. These two new projects provide advanced sensing capabilities which help our customers become aware of operational performance issues and potential problem areas before they cause inefficiency or unplanned down time.

Slide 22 takes a look at many of our developments around the pursuit of alternative energy sources. There are several active projects in this area either under way or in the advanced stages of development. These include clean coal, solar power, bio fuel, and our recently announced commercialized systems for natural gas and bio gas refueling stations for automobiles, trucks and buses through our Flowserve compression system joint venture with Linde in Austria. There are also other areas in early development where we are partnering with customers on either pilot or research projects. These include geothermal power, wind power, compressed hydrogen gas fuel and ocean energy conversion.

In closing it's important to remember that history tells us that businesses may pass through several cycles over time. However, history also tells us that there continues to be investments in infrastructure development and after-market support during all phases of these cycles. This is driven by the need to keep oil and gas flowing, water and critical chemicals available and electricity on. As I have discussed in the past we have found that customers will continue to select companies who deliver on time, deliver an effective product and can provide a global support network even during the challenging times. As I have discussed in the past we have found that customers will continue to select companies who deliver on time, deliver an effective product and can provide a global support network even during the more challenging times. I believe that our leadership and strength come from our ability to deliver on these core customer requirements which in turn positions us to be successful during all phases of the business cycle. I would now like to turn the presentation over the Mark to further discuss our financial statements. Mark.

Thank you, Lou, and good morning everyone. As Lou mentioned we are very pleased with our third quarter and year-to-date results as we have seen strong orders in sales growth and strong margin improvement. This morning, before I review the financials, I'll cover a few topics and highlights relative to our business today. I'm going to spend a little more time on these current issues and, more importantly, how we are positioned. The first topic is the credit markets.

The world has seen unprecedented times in the global financial markets and it is important to note that Flowserve has a durable capital structure, and I will review that in a moment. We are also continuing to monitor customers, financial relationships, counter parties and suppliers, and we have not seen any problems. A consistent theme we have discussed for many quarters is to strengthen our after-market business. We have seen strong execution on our after-market strategies reflected by 17% year-to-date growth in Flowserve after market business, including 20% growth in the pump division.

As we look at cycles, after-market provides a sustainable, high margin earning strength. We have also seen strong operating margin expansion of 340 basis points driven by operational excellence, a mix to higher end products, improved pricing, and volume leverage resulting in gross margin improvement of 220 basis points. We have done this while remain focus on cost containment resulting in a reduction in SG&A as a percent of sales of 140 basis points year-to-date.

With respect to tax, we have seen net benefits of tax items of $0.22 in the quarter and $0.38 year to date, and we now estimate our full year tax rate of approximately 25%. Another business indicator which has remained strong over the last four quarters is cash flow generation. The third quarter was no exception with the generation of $173 million of operating cash flow.

Now let me take a moment the talk about currency and how it impacts our business. As we have often discussed, about two-thirds of our business is international. This means revenues, operations, people, QRCs, two-thirds is international. We do use foreign currency contracts to hedge future cash flows. What I mean by this, where we secure a contract in dollars that is going to be manufactured in Europe, we hedge those cash flows at the time of the receipt of the order out to the period when we expect to receive cash and we use forward currency contracts. The impact of the economics of the order are reflected above the line and the impact of the hedging activities are below the line.

If you look at the first half currency, we had a benefit above and below the line based on the strengthening of many foreign currencies. Most notably, the Euro from 1.46 to 1.57. Recently, we have seen a dramatic strengthening of the US dollar against all Flowserve significant currencies and this has created an impact. The reason I highlight all currencies is some currencies in the first half didn't strengthen against the dollar, but we have pretty much consistently seen a lot of those currencies weaken in the last couple of weeks.

So as you look at our July guidance, we based on a EUR1.57 for the second half of the year. When you consider that actual rates for Q3 of 2008 and spot rates recently for Q4 of 2008, you can see that it has driven an adverse impact of $0.60 for the second half of the year, including an estimate approximately $0.40 in the first quarter, and that is above and below the line. However, if you look at our guidance, the bottom line is that we have been able to counter the impact of this currency with strong operational performance and a lower tax rate. And as Lou mentioned, one important factor is that the weakening of the foreign currencies does provide a benefit to our international operations.

So looking at the third quarter and year-to-date results, you can see we had strong sales and even stronger orders, as Lou mentioned, which provides a solid backlog for Q4 in 2009. If you look at gross margin, gross margin improved 100 basis points in the quarter and 220 basis points year to date despite shifts to more original equipment in our pump and seal division. In fact, we even increased gross margin to 35.4% year-to-date. If you look at SG&A, we have seen tremendous leverage in SG&A with an improvement of 170 basis points in the quarter and 140 basis points year to date.

As we talked about before, over half the increase in SG&A is selling related. We have also seen corporate expense drop down below 300 basis points as a percent of sales. When you look at the year over year compares for the quarter and the year, it is important to note that we had $9 million in reduced legal costs for the quarter and approximately $18 million year to date. We're continuing to drive SG&A as a percent of sales to 20% or below, which is our target. If you look at operating margins as a result of the leverage in gross margin and SG&A, operating margins improved 240 basis points to 14.2% in the quarter and 340 basis points to 13.7% year-to-date. And contribution margin for the quarter was approximately 23% and it is almost 28% year-to-date. When you add the benefit of tax rate leverage, we're getting tremendous earnings leverage in our P&L.

Now I'll turn to the divisions. The pump division has had a great year highlighted by strong third quarter order growth of 44% including 35% organic growth. And strong year-to-date order growth 33% including 22% organic growth. I highlight this year-to-date because as we look back at the second quarter we notice that orders were -- organic orders were 7.5%. This reminds us that this is not a quarter to quarter business. The bottom line is that the trends are strong.

If you look at their gross margin, they have had gross margin improvement of 70 basis points in the third quarter to 30.5% despite a 600 basis point mix shift. And for the year they have seen a 300 basis point improvement in gross margin despite 100 basis point mix shift. This is being driven by operational excellence, a mix to more high end products, pricing, and fixed cost leverage. When you combine the gross margin improvement with good expense control in SG&A you get a result that is 160 basis points of margin improvement to 15.5% for the quarter and 310 basis point improvement in margin to 15.3% for the year. With a solid order book and the improving margins, the pump division is well positioned.

The next slide just shows a break out of mix between after market and original equipment. And what I'll point out is that we have had strong after-market growth for the year of 20% in bookings and 24% in sales. This is important to note because this is well above the market growth rate.

Looking at the valve division. The valve division has demonstrated consistent improved performance for the last three years and the third quarter was no exception. They saw strong order in sales growth, notably in the chemical and power markets. And if you look at their gross margin improvement of 200 basis points in the quarter and 110 basis points year to date, you can see that they're converting their opportunities in an improving operating environment. Their gross margins are running at 35.9% year-to-date. They're doing this through good product management, R&D initiatives, lean, CIP, and low cost sourcing just to name a few.

They've also done a great job on cost management as they have driven SG&A to 20% as a percent of sales while still investing in selling and R&D. Similar to the pump division, the result is tremendous operating margin expansion. 280 basis point s in the quarter to 16.7% and 210 basis points to 16.1%. This team has really transformed this business over the last few years and there are plenty of opportunities ahead of them.

The seal division has had another strong quarter highlighted by continued strong orders and sales growth. They've accomplished this growth while continuing to sustain high gross margins in excess of 45% despite a shift to more original equipment. This shift results from their strategy to increase their installed base where they have, or more importantly, plan to have an after-market presence.

Looking at SG&A we have often discussed that they have been investing in their business. They have invested in selling, expanding their [QR seat] network, expanding the capabilities of their auxiliary manufacturing facility to support the global market, and they have invested in engineer systems and machineries to drive a global standardized platform. They have done all this investment while maintaining operating margins year to date of 19.5%. This investment will enable them to continue to take share in sustained solid operating margins.

Looking at our primary working capital, the growth in receivables of $245 million include the impact of $70 million of factored receivables that are no longer factored and also we have seen an increase of approximately $100 million year-to-date in progress billings. In inventory, inventory grew $179 million primarily driven by work in process in the pump division. Also in these working capital numbers is the impact of the [Nagada] acquisition approximately $30 million. If you look at advanced payments, advance payments increased year to date $134 million which secures our backlog and also helps offset the working capital impact.

Looking at third quarter cash flows. As I mentioned earlier, we had a very strong cash flow from operations in the third quarter of $173 million. We continue to invest in our business with $36 million of capital spend and we returned $114 million back to our shareholders in the form of dividends and share purchases.

The next slide is what I referred to earlier demonstrating the strength of our balance sheet. If you look at our term [debt no revolver], these facilities are committed to August 2012. You add to that the cash on the balance sheet at the end of the quarter of $154 million. And also, as Lou mentioned, we were able to upsize our letter of credit facility. Bottom line is at the end of the quarter we had approximately $500 million of capacity and we are well positioned going into what has historically been our strongest cash flow quarter.

So, looking at the chart on our drivers of EPS growth, we're well on track on our key initiatives to drive gross margin in SG&A improvement. We've also seen other tax rate and we estimate it to go to approximately 25% for the year through planning and certain tax items. We talked about the impact of foreign currencies. Looking forward, we now expect 2008 EPS target at around the upper end of our previously announced range.

We will continue to stay focused on driving our strong end user strategy in taking after-market share as this will drive sustainable high margin earnings. We'll be focused on continued cost containment to drive SG&A as a percent of sales down. We will maintain a strong balance sheet, available capacity and financial flexibility. As I mentioned, we do expect our tax rate to be approximately 25% for 2008 and as I always mentioned, execution is still the focus in our business. We are going to take advantage of opportunities and continue to improve the platform. We believe we are well positioned. With that, I'll conclude my comments and turn it over to question and answers.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Michael Schneider of Robert W. Baird and Company.

Good morning, guys. Congratulations on a great year so far. Maybe first we can just talk about the mix because I guess even I am astounded that the 6-point shift now towards project activity versus after-market. Can you give us a sense of is this rate or is this mix sustainable into Q4 and into early 2009 or is there some reversal that we should expect now as the cycle gets longer?

Well, as we talked about before, Mike, one of the things in the impacted shift is our tremendous success in growing our after-market business. But as we talked about over the last quarters and even ending last year, you have seen the bias relative to current mix to more original equipment, so that persisted again year to date and even in this quarter because we had 69% original equipment in orders and 31%. So that should indicate that there is still going to be a shift mix relative year-over-year. Having said that, I think one of the important things to note is that we continue to drive gross margin improvement. So as we talked about before, original equipment is good business. So we look at it in terms of absolute growth in each one of them in terms of original equipment and after market.

Okay, in fact on that topic of the gross margin benefit, I think historically you have said each point shift translates into about a 30-point change in gross margin. Year-to-date now we've seen a 1 point shift and yet gross margins are up 300 basis points. So I'm curious, has that relationship held? Just so we can get a sense as we model now I guess at some point I guess in '09 the reversal of this mix shift, does that reversal still hold such that as after market grows as percent of mix for each 1 point we're going to see 30 basis points of gross margin benefit?

Yes, well that is kind of a theoretical application, and one of the things that has changed since we talked about that a year ago is that the margins in our original equipment has gone up. A lot of that is we've talked about is certainly pricing. But also if you look at this business over the last five, seven years, we have seen more of a migration to our higher end products. That's what Flowserve offers and those tend to command higher margins and also lead to more after-market opportunities. So the 30 basis point holds roughly. It will tend to shrink down as original equipment margins go up. Often we talk that after market margins are fairly stable. So it is a good proxy for modeling, but it can certainly change relative to how many specialty pumps we may ship in the quarter. And, again, we're seeing more and more of those.

And have the markets risen over the last 18 to 24 months?

As I have said, they have been pretty consistent. We have seen a little bit of pricing in certain parts, but service tends to hold fairly stable through the cycles. But nothing really noteworthy in terms of price increase to talk about.

Okay, then I'm just curious when I look at your pump and valve market sales figures historically and I'm referring specifically to slide 20, if you look at the after market it goes back to 2004. I'm curious about what the after-market did at least the other data sources you use going back to '98, '99, then 2000, 2001. Did it decline or was that all project mix that declined, at least in the charts you're using?

Mike it is difficult to use that data going back to that period of time because we were not even Flowserve as it is today. That was prior to the IDP acquisition. I can tell you -- I can give you some anecdotal information. One, the after-market strategy was much more of a break fix at that point in time. And also as I talked about, there tends to be a higher concentration of more process pumps and product pumps. We've seen a migration of more higher end product over the last couple of years, so I'm not sure that that information would be really relevant.

What we can say, and we talk about this before, is through cycles, after market tends to remain fairly firm. There are commission spares that sometimes are in the project or after market that go with the new project. But, for the most part, if you think about what can occur in a down cycle is they still need the maintain the facilities in a state of repair and those will certainly be opportunities where they are going to look for efficiency. If you think about the immediate profit pool that an operator is going to go to is he is going to try to maintain and increase the efficiency in his existing facility. And the other thing is if you look at it, they will be looking for ways to get rid of fixed costs and that provides certainly the opportunity to out-source their service to us. I think a lot of those things combined with our execution, improved execution, over the last couple of years, really makes us a different after-market business than you would have seen in 1999.

Well, in fact all those factors, both internal and external and especially now the large install base that you put in place over the last two years, shouldn't that actually argue that after market say for the foreseeable future continues to grow even if project activity rolls over substantially because now you're servicing a significantly larger installed base and you're servicing it more effectively?

We're continue to execute and take care of our customer, yes.

Okay. And then final question on the tax rate, so 25% is the Q4 number, I'm sorry, the 2008 number. Can you give us some sense? Has that rate change meaningfully in 2009 or is that a sustainable rate?

Well you know we talked about that before. We said in the last call our structural rate was approximately 29% and that we're going to continue to invest in planning opportunities. We haven't given any further guidance on that, so that is where we are at this point. But I will tell you we are going to take advantage of certainly being a global international company, continue to invest in tax planning, and with the focus of driving that down as we have over the last couple years.

Well, I guess the core question is have you as a result of all the activities during 2008, reduced your structural tax rate or are these just all one-time settlements with different tax authorities overseas?

We are where we were last quarter at this point. We haven't provided any additional update. Our structural rate is approximately 29%.

Okay, thank you.

Your next question comes from the line of Charlie Brady of BMO Capital Markets.

Good morning, guys. Can you just talk about where you are in terms of capacity. I guess particularly in Latin America you talked about the activity that has gone on down there in the oil and gas market maybe needing some capacity, where you are on that. And just for broad terms what you're doing. Do you feel comfortable where you're at in capacity right now?

Let me answer the second question first. We do feel comfortable with our capacity not only because of the physical capacity we have worldwide, but how we are managing it. We are managing it on a global basis. On your first question around Latin America, you're right. There is a lot of opportunity there. Flowserve has been there a long time, so we're not new entrance in that market. But we are investing in capacity down there. First of all, we've talked about this, we're going to build a new facility in Brazil, outside of Rio de Janeiro. We have a facility there right now that is servicing our customer. But in talking to our customer we see a lot of opportunity going forward. So we have committed some capital to build a new facility. I think equally important is around Brazil and other parts we're investing in QRCs because they have a lot of infrastructure that is being serviced by local machine shops and that is an opportunity for us and we're going to be investing down there. So we're going to take advantage of the opportunity in Latin America.

Going back to the prior question in the gross margin increases in the faces of significant swing to the OE mix. How much of that is out of price and how much of that is coming from internally generated better operational manufacturing?

Charlie we don't break that out specifically. But I think if you look at the contributors, certainly price is provided a benefit because that tends to almost flow through except for the commissions you paid to your selling organization, but we have seen a substantial benefit from operational excellence and the way that really shows is you have just seen regardless of mix, you've seen good gross margin improvement really across all three of our divisions. So that has been a consistent theme. Also, you see things in terms of the products that we're putting out there. We have migrated our products to some of the higher end products available out in the market. Remember in the second quarter we talked about some specialty pumps that we shipped and how that impacted gross margins. And also we get volume leverage as well. So all those are contributing factors, but I think price is not necessarily the number one contributing factor. When we look at it, we think operational excellence and where we are taking our products is really what is driving the margin improvement.

Thanks.

Your next question comes from the line of Amit Daryanani of RBC Capital Markets.

Thanks, good afternoon guys. Just a --

Good afternoon.

Just a question on the cancellation side. I realize you guys talked about not seeing extraordinary cancellations. But are you seeing OEMs maybe pushing out the delivery schedules at this point?

We really haven't a seen very much of it. We're hearing some anecdotal terms that is there is some possible delays. But as far as cancellations are concerned, we're really not seeing anything out of the ordinary. As I said, there is just some talk out there but really nothing that we can put our finger on at this point in time.

All right, and then I guess you know in terms of looking at the capital usage going forward, you guys seem to be fairly comfortable with the amount of debt that is on the book. You should generate a good amount of cash going forward. Can you just talk about what you perceive to be the biggest priority of the cash usage given that I think you are about half way through the $300 million buy back program you guys had.

Yes, Amit. It is interesting how times change, right, because three weeks ago the order of the day was having as much cash on your balance sheet as much as possible and that is a priority to us. I think it is important to note that we look at this Company in our balance sheet really in the interest of our shareholders. So we want to make sure we have adequate capacity to weather whatever happens in these credit markets. But that aside, we'll continue to deploy our capital as we have in the past. We will look at opportunities to return value to the shareholders. We bought $100 million of shares back during the third quarter. We think that is a good way to return value to our shareholders. We have committed to the dividend. You see a lot of companies now that are pulling theirs down or taking them off. We have committed to that because we believe in our cash flow. Also keep in mind we have been investing increasing amounts in our business and capital expenditures. You saw $36 million in the quarter. I talked about our investment in Latin America next year. We're building out our facility in the Middle East standardizing our machinery. So we have good uses for cash. What we typically do is we'll talk about that cash and how we plan to use it in going forward at the beginning of the year. But this year, just to highlight what we did, we went off the factoring program, used cash, we topped up our pension plan which is good for employee morale, so we think we have invested it wisely.

The fact that you guys bought back stock in this quarter about $125 roughly per share and the stock is rating almost more than half of that right now, so I was curious if the priority to buy back stock at this point was bigger than keeping cash on hand given uncertain macroenvironment?

Well, a couple of things, Amit. The drop in the markets has been fairly precipitous over the last couple of weeks. Keep in mind our window closed for repurchasing shares September 15, which is our blackout period. So we don't have the opportunity to do anything afterwards. But even when we bought these shares back during that period of time, we looked at our cash flow generation opportunities and felt very comfortable with repurchasing those shares under our program. And, again, we feel very comfortable with our cash position right now.

Got it. And just finally, could you just maybe talk about what percent of your building material is procured on a global basis? Where do you see that percent trend over the next 12 to 25 months and also how much of the production is done in low cost regions today?

If you look at the different divisions, all have a different amount. We don't really put out all those numbers. But I can tell you that on the valve side we're probably north of 30% in low cost areas and a little bit lower in the pump and seal side. So we are doing a significant amount of low cost purchasing. Remember, most of our small parts, sub assemblies, a lot of that we actually build in places like India and China, then we'll ship them back into Europe or the US or we'll do final assemblies in the low cost countries.

We talked about the investment in Latin America. We have facilities in Mexico, Argentina, Brazil and we see that as an opportunity to be a low cost source region in the world as well. That's why we're making investments.

A final question for me, I'll hop off after that. I think last quarter you guys at least talked about bookings in the second half of 2008, the pumps would be higher than the first half. Given the strong bookings in Q3, are you still comfortable with that statement?

In terms of the back half of the year? Yes, we made the comment, if you remember in the last quarter, talked about pump bookings. And the reason is just to remind you is we're not a quarter to quarter business. As I illustrated in my comments, we had 35% organic growth this quarter versus 7.5%. So looking forward we were confident with our bookings. The only thing I will say is what happens to currency. We have seen dramatic moves in currencies and that does impact our reported bookings, but not necessarily our organic bookings. So that's one thing we just don't know what's going to happen to the currency because we have seen a significant move in the last two weeks.

Thanks a lot, guys.

Your next question comes from the line of Scott Graham of Ladenburg.

Hey, good afternoon now. Try to make my questions brief and possibly get back in line. Would you guys be able to split for us on the bookings and the backlog, particularly the bookings the percentage of bookings that are actually after market? I assume it is pretty small, but nevertheless.

You mean the backlog or the bookings we kind of laid out for the pump division and year-to-date our bookings growth has been 17%. So we do have that data. In terms of your question is the backlog, what percent of that is. You're right, there is after-market orders that are back logged, but a predominant amount of that backlog is original equipment orders.

So defined as 90% plus?

I don't have that number specifically and we don't provide that specifically.

And the bookings, the answers are kind of the same, yes?

Yes, in terms of bookings, you can see the mix. For example, in the pump business you can see for the quarter it has been 64-36 is the mix -- I'm sorry, I'm booking 69-31 and basically two-thirds year-to-date are original equipment one-third is after market. In the seal business we have seen a little bit of a shift in their bookings to more original equipment based on their strategy. But they have historically held about 75% after market and 25% original equipment. And just to break out in the valve division, the breakout, as we report it, is usually about 85% original equipment, 15% after market but, as you know, some of that original equipment in that 85% is really after market. It goes to distributors where they just replace the valve. And it has after-market response times and after-market response to it.

Understood. That is helpful, thanks. You have both manufacturing and quick response centers around the world that appear to be finding more and more opportunities that continue to drive your bookings and sales. Relative to the previous question about uses of cash, because I think we're all pretty much modeling the same thing, that in the absence of another share repurchase program, you guys are going to have a significant amount of cash on your books by the end of 2009. So I'm wondering, let's say that there is another share purchase authorization. Is there a real CapEx opportunity here to increase the number of QRCs? Are you considering that? Are you considering an investment in the pension plan to lower your pension quarterly expense? Maybe if you can get a little bit more granular, Mark and Lou, on what those uses, maybe even if you can itemize the uses of cash and prioritize.

And, as I mentioned earlier, Scott, this is typically something we do on our year-end call. But let me just talk generally on this point. We'll always look at our pension plans, I think you mentioned that. We certainly top it up in the US pension plan this year, but with the way the markets have responded, all assets have depreciated in price. So we'll certainly take a look at that going forward. We had the event of going off of factoring in a sense, and we're pretty much done with that. But looking forward, we're going to spend a lot of money in capital this year. If you look at our investments in Dubi, in Saudi Arabia next year we're going the spend the money to build our Brazilian facility and build out some QRCs. I do think there is still plenty of opportunity for us to build out our QRC network, keeping in mind that this is not like a retail chain where we build it and then try to seek customers. We work very closely with our customers to determine where is the best place to put our QRCs around the globe. But, yes, we do have opportunity to continue to invest. We have not completed our share repurchase program so I don't want to even talk about a second one until we've completed this one. But we'll be thoughtful with our cash going forward and, as always, we'll take a look at how we return cash to our shareholders. You've made the point and historically we generate a lot of case in the fourth quarter, that typically historically been when we generate a lot of it, and that is what typically precipitates the conversation in the beginning of the year, how we intend to use our cash that year.

Okay, last question is along the lines of the strength in the dollar. Is there, really two parts of this question. Number one, are you actually seeing anything yet maybe on a short cycle stuff that suggests that lower local currency valuations are actually helping you competitively? Is that something that you guys are starting to maybe measure a little bit and then, secondly, I know what the mark to market was for the third quarter. What I'm obviously trying to do here, and I suspect others are, is to understand the translation piece of the $0.60. Would it be fair to say that the mark to market in the fourth quarter would be roughly the same in the same vicinity as the third quarter and the rest is translation?

Yes, so let me -- let me go to your second question first, and then we'll go back to your first one. In terms of the currency, we didn't provide, we indicated an impact, an estimated impact of $0.40 in the fourth quarter. And basically what we did there is we went back and looked at our guidance on the last call and said what would the impact have been based on what we saw in the currency in Q3 and what we're estimating Q4. And, for example, the average we used is 127 for the Euro and it might be there today and it might not. So as soon as we got that estimate it has changed. So I think we didn't want to go into much further detail in terms of above or below the line.

You can see the mark going from 141 to 127 is approximately to your point of what it was in Q3. And in terms of the translation benefit, you can see the benefit that we saw above the line in the first half of the year and try the estimate what it will be in the last half of the year. I think an important point on currency is that is something that is driven basically at translation, benefit first half of the year and will have an impact on the back half of the year and also a mark on our hedge. The cash flows are hedged. That is important from an economic standpoint. And I think another thing in terms if you look at our guidance, we have been able to counter that impact with operational performance and a lower tax rate. And, again, what was your first question?

Thank you for that I suspected the same and I appreciate your -- your granularity on that. The second question was simply are you guys in fact hearing from your operating units that hey, this strength in the dollar thing is really helping us out?

Well, the change has been very, very recent. But I can tell you what we heard as the dollar was weakening with really no end in sight. And this was back last July. We actually saw some of our facilities that were starting to put currency contingencies in their bids in our European facilities because their costs were going up at such a rapid rate. They didn't know where they would be during the bidding process. That's what kind of gave us the indication that whenever these currencies move real fast it changes and we can respond. What we did see is that it put a lot of pressure on our bidding process in our European facilities as they became very expensive in terms of a cost structure. Similar to us traveling over to Europe as a tourist, everything got really expensive really quick.

Understood. Thanks very much. Good presentation.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of [Neil Consari] of [Sanz Capital Management].

Hi, congratulations on a good quarter.

Thank you.

I just had sort of a big picture question. Could you expound a little bit on how your position in these emerging markets relative to your competition in China, India, you spoke a little bit about Latin America, Middle East but how you positioned relative to your competition in these markets?

Well if you take a look at India, we have nine factories in India plus QRCs. Some of those are joint venture factories in the valve area, but we have joint venture pump facility. We have our own pump facilities. We also do, in fact, most of our design of seals in [Chinai]? So we have facilities in [Bangalore, Chinai and Combitor]. Compared to you our competition, I think we're outstanding shape in India. In China, we were a little bit late getting in to. We let other people get in their first, even though we were in there for about 40 years but not with manufacturing capability. So we let our competitors get in there, make the mistakes that we all make when we first enter into a country.

Then we went ahead and built greenfield facilities about a year and a half ago in the pump, valve and steel area. They are now fairly full facilities. We also have a number of QRCs, and we're planning putting a number of other QRCs into China. So I think right now we're very competitive in China. We're seeing a lot of business, in fact business that we never saw when we were importing into China. In most of these country, India, China, especially Brazil, you have to be part of the economy. You have to have factories and people on the ground to really see all the large projects. They all want a certain percentage of internal workings in their projects. And now we are in all these areas. We have factories on the floor and we are very competitive.

And Latin America, as Lou, mentioned we had been there for a long time. But it is fair to say over the last 10 years we kind of lost our number one position in that region. And that is why we're making the investment because we think with our model we have the opportunity to take it back. So that is an area of focus for us.

Well, another question. This is on the -- you mentioned that there has been migration to high-end products. What portion of your overall sales is sort of these high-end or specialized pumps where only the big three or four, you have the by three or four competitors versus the more commodity-type products where there are 100s?

Sure, well we don't break out the specific in terms percentages of our mix but I can tell you generally it depends on what competitor you look at. Some of our competitors offer high end high energy pumps that have sophisticated engineering. But it is generally fair to say really in all of our divisions we have been migrating our products to more of what we call the tier 5 or higher end product line. And the reason we do that is you get paid for the engineering, you get paid for the capabilities and, more importantly, they really lend themselves to our after-market strategy. What we have done with some of our more processed pumps, even though they require engineering and they do drive after market, is that is a lot of product where we have moved the manufacturing or the sourcing to low cost parts of the world.

Last question, in terms of your software capabilities with some of these advanced inner solutions, how does that -- how accepted is that as total life cycle cost perspective from a customer standpoint? And, again, how long have you had sort of those tools for your customers?

That is a great point. Because I think in the comments earlier I think we talked about historically we offered a great fix model. And if you think about the purchase division, the purchase -- there was a great strategy behind it. Where the customers have migrated is right on your point. What they want is quality, they want precision, they want responsiveness. If you think about what a software system can do for us is it really enables that. It allows us to move 24-7. It allows us to move specifics to a manufacturing facility. More importantly it allows us to give the customer real time what they want. And if you think about that, these pump, seals, valves are very highly engineered. If you're off by a little bit you can substantially decrease the effectiveness or the efficiency of the piece of equipment. So I think they're seeing that. I made my comments earlier about efficiency. We see a lot about greenfield projects out there but you also see a lot spent what I call brownfield. And that's where looking to make these facilities more efficient. As Lou talked about, they're antiquated and they are running less than optimal and that is our opportunity to go in and drive real value to the customer by increasing the efficiency.

And just follow on that, how would you compare your software capabilities relative to an ITT or whoever?

I'm not really too familiar with their software capabilities, to be honest with you, but I think our capabilities as we are driving and we are continuing to make investments will really position us well relative to our competitors but more importantly in the eyes of our customers.

Okay, thank you very much.

Your next question is a follow-up from the line of Scott Graham of Ladenburg.

You have a slide in your presentation, Lou, where you talk about be prepared. And I'm wondering what happens -- what is the first or first and second levers that you pull here when you do see the OEM bookings slow down and you realize that operational excellence maybe needs to accelerate and other things need to happen. What are some of the first levers that you pull?

Well, when we're watching and we continue to watch, we have been doing it for years of what is going on out there, but if you look at levers that we have, they're really listed on the chart. Having multiple shifts as an example versus building brick and water, if you have to you can back off on a third [ship], you can back off on a second [ship]. Those are important ways of removing people if that is really needed. We also have the ability because of the processes that we have when we win a job, we can move equipment say in a facility in the US to Europe or from Europe to Asia or around the world and build it in a different location.

Having temporary employees, when you have a down turn, a possible down turn, that is one of the original places or immediate places that you turn to if you want to reduce your cost. But all three divisions constantly watch costs around the world. It is not something that you just sit there and wait for a phone call saying oh no, things are bad. What we do is monitor on a continuous basis, we make changes on a continuous basis, and that is why we use the word "be prepared" because we are and we have been.

And one thing to add to that, Scott, as Lou mentioned earlier in his comments, these markets don't go away. So what we do is we drive to deliver incremental value to our customer in terms of the products that he has in his facility, but also, as we've talked about, we're present, we're proximate to the customer. It generates sustainable earnings but, more important, when that project does come up, you're there and you're ready.

And the other is, of course, we really want to drive increased market share. When things start to go down, if they do start to go down, the ability to get market share is extremely important, because you can go in there and if you are delivering on time, which I talked about many, many times, you delivering a product that works when you get it there. You have that worldwide network support of products, you can truly go after other business that your competitors have and drive market share up.

That is great. Thanks a lot guys.

(OPERATOR INSTRUCTIONS) There are no further questions at this time. This concludes today's conference call. You may now disconnect.