福斯 (FLS) 2012 Q3 法說會逐字稿

Welcome to the Flowserve Q3 2012 earnings conference call. My name is Kim and I will be your operator for today's call. At this time all participants are in a listen only mode. Later, we will conduct a question-and-answer session. I will now turn the call over to Mr. Mike Mullin. Mr. Mullin, you may begin.

Thank you, operator. Good morning and welcome to Flowserve's third quarter 2012 earnings conference call. Today's call is being webcast with our earnings presentation via our website at Flowserve.com. Simply click on the investor relations tab to access the webcast and the accompanying presentation. The webcast will be posted at Flowserve.com for replay approximately two hours following the end of the call. The replay will stay on the site for on-demand review over the next several months.

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

Regarding any forward-looking statements, I refer you to yesterday's earnings release, 10-Q filing and today's presentation slide deck for Flowserve's Safe Harbor presentation statement on this topic. All this information can be found at Flowserve's website under the investor relations section. We encourage you to read these statements carefully with respect to our conference call this morning. Now I would like to turn it over to Mark to begin the formal presentation. Mark?

Thank you, Mike, and good morning, everyone. As everyone is likely aware, hurricane Sandy continues to impact the upper East Coast of the United States. At Flowserve our number one priority is always safety. Many of our associates and operations are located in and near affected areas. Likewise, we know that a large portion of the financial community and many of you participating in today's call are facing these difficult conditions as well. We sincerely hope that everyone remains safe and out of harms way. We want everyone on the East Coast to know that we are thinking of you and your families and wishing you well. Let me now begin our prepared remarks.

I am pleased with our solid third-quarter results driven by operational progress resulting from our One Flowserve initiative, as well as the steps we have taken to improve our capital structure and ultimately increase shareholder value. I am proud of Flowserve's strong culture of customer commitment and our employees dedication in positioning the business to target and grow bookings in our diverse end markets.

While our current outlook is somewhat cautious due to the soft macro conditions in Europe, as well as moderating growth in Asia, which together have increased uncertainty in our end markets, we continue to focus on the items we can control to best position Flowserve to capture the infrastructure investment that is needed around the world, including our successful aftermarket business.

This quarter, we delivered solid earnings growth in spite of significant currency headwinds. Mike will provide further details, but as you know, a strengthening dollar materially impacts our reported results since nearly two-thirds of our business is outside the US and subject to currency translation. Our bookings growth of 2.3%, or 9% when adjusted for currency, included our first large project order of the year. IPD booked over $90 million of original equipment orders to support offshore oil and gas development. We remain optimistic about the medium to long-term infrastructure investment opportunities in our energy end markets, particularly in North America, the Middle East and Brazil.

Additionally, our focused end-user aftermarket strategies continue to produce positive results. We were recently awarded a five-year service agreement with Dell Benelux to perform maintenance of its rotating equipment and general machining in its Dutch facility. Our commitment to localization includes the buildout of a QRC to support Dell, as well as other customers in the area. This is a great example of the types of programs our end user strategies target and the value we can add as customers increasingly look for a trusted partner to help improve the efficiency of their facilities and better manage their smaller service vendors.

Operating margins improved sequentially and year-over-year in spite of the overall mix shift to lower margin original equipment. Margins were also negatively impacted by shipments of lower margin legacy backlog. Our improved margins reflect the operational excellence progress that Tom and his leadership team are making, as they drive on-time delivery, lower past-due backlog, manage costs, improve the supply chain and reduce the cost of quality throughout the business. We believe that we are gaining share in many of our markets, while we simultaneously increase the discipline and selectivity of our bidding process. Also, we continue to see steady progress in IPD, as it moves towards its 14% to 15% margin goal. Simply put, I am pleased with the progress of Tom's team, but opportunities remain for further improvement.

Our solid backlog of nearly $2.9 billion, up over 7% since year-end, has us well-positioned to deliver on our financial targets for 2012 and beyond. We are particularly pleased that the quarter and aftermarket backlog exceeded $700 million for the first time. And I am proud that we have been successful in consistently growing our aftermarket franchise, even through difficult market conditions in 2009.

Turning to our business outlook, softening economic conditions in certain regions may push-out the timing of some previously expected later cycle large project investments. We remain confident that these projects will go forward, since these investments are needed by the increasing global urban populations. Market uncertainty and volatility highlight the importance of Flowserve's diverse global platform and its ability to mitigate risk, especially through our aftermarket end user strategies.

During the quarter, we also executed our long-term strategic initiative to improve the efficiency of our capital structure by taking advantage of our investment grade status and attractive debt markets. We also continued to execute on our previously announced $1 billion share repurchase program, which we expect to complete next year. Even as we improve balance sheet efficiency, our commitment to increasing shareholder value through profitable growth remains, both organically and through bolt-on acquisitions. We will pursue opportunities to fill product, geographic and technical gaps in our portfolio using a disciplined process focused on growing long-term value for our shareholders.

Looking forward to the fourth quarter and full year 2013, I am confident, as evidenced by our strong year-to-date performance through the third quarter, that Flowserve's combination of operational improvements, the diverse end markets in geographies we serve and our almost $2 billion annual aftermarket run rate, position us well to continue to capture profitable growth, margin improvement, share gain and create long-term value for our shareholders, even while considering the continuing uncertain and sometimes volatile macroeconomic environment. With that I will turn it over Tom.

Thanks, Mark, and good morning, everyone. As Mark discussed we're pleased with our third quarter results, with bookings of $1.19 billion, up 2.3% versus prior year, despite the impact from a stronger US dollar and the economic challenges facing Europe. Our consolidated book to bill was 1.02, driven by a solid aftermarket book to bill of 1.04. While we continue to see elevated levels of feed and pre-feed activity through the third quarter versus prior year, we now anticipate the larger mega project orders shifting to the mid to second half of 2013.

Turning to our year-to-date bookings by end market, we saw strength in the oil and gas and chemical industries, along with modest growth in the general industries and water business. Regionally, the improvement has been concentrated in North America, Asia-Pacific and Latin America, partially offset by lower bookings into the Middle East, Africa and to a lesser extent, Europe. Overall the oil and gas business continues its broad-based positive long-term outlook, with North American pipeline business positively reacting to increased oil and gas transport activity.

Other areas of pipeline project developments showing promise include the Middle East, Argentina and Colombia, with offshore platform work continuing in Brazil. In August we had a grand opening of our $37 million Rio plant investment that allows Flowserve to expand our existing footprint in the Brazilian market, including a state-of-the-art test facility.

In the power market, coal fired plant opportunities in China and India remain on the horizon, as well as the potential for coal to gas conversion opportunities in the US for both full and partial conversions. With the abundance of shale gas, combined cycle plants will bear the brunt of providing new capacity requirements. The chemical market has seen good growth year-to-date, particularly in China and the Middle East. Additional shale gas finds in the US and the abundance of existing shale gas will allow new chemical production to take place competitively in the US for the global marketplace. Fertilizer plant opportunities also continue to drive the market. The mining sector has been mixed, with concerns about overcapacity and demand, particularly in Europe and to a lesser degree in China, which have dampened the short-term outlook.

Turning to the year-to-date sales mix by region, we grew the top line 5.5% or 11.2% on a constant currency basis. We have seen strong activity in Asia Pacific and North America and an increase in Latin America, which more than offset European weakness. Now let me discuss our segment results for the third quarter. The engineered product division bookings decreased $14 million to $554 million, down 2.4% but up 4.1% on a constant currency basis. Oil and gas bookings increased in the quarter, along with improvements in the water bookings in North America, offset by a decrease in power. Regionally, we saw higher bookings in the Middle East and North America more than offset by decreased bookings into Europe, Asia Pacific and a slight decrease in Latin America.

Sales decreased $7 million to $568 million, down 1.2% but up 5.3% on a constant currency basis, driven by lower originally equipment sales and decreased sales into Europe and Latin America, partially offset by higher activity in Asia Pacific and North America. Aftermarket sales increased 2% or 7% on a constant currency basis. Gross margin increased 30 basis points to 33.9%, positively impacted by some shipments of higher margin backlog as compared to the first half of 2012, as well as a mix shift to aftermarket sales and the benefits of lower cost associated with operational execution improvements.

Operating margins declined 70 basis points to 15.3%, due primarily to higher SG&A on increased sales related expenses. EPD signed a five-year services contract with Dell Benelux to provide maintenance and machine shop functions in the Netherlands to support Dell's local rotating equipment population of around 7000 pumps. This maintenance agreement effectively outsources this work to Flowserve.

Bookings in the industrial product division increased $60 million to $284 million, up 27% or 34.6% on a constant currency basis, driven by improved activity in the oil and gas industry. This was due in large part to original equipment orders in excess of $90 million to supply thrusters over the next five years, which are used to stabilize and position offshore oil and gas platforms. This strength in Latin America, combined with increased North America pipeline activity, were partially offset by some softness in Europe. Chemical orders were also up. Sales increased $28 million to $244 million, up 13% or 18.6% on a constant currency basis.

Strength in Asia-Pacific, North America and Latin America was partially offset by lower sales into Europe. Original equipment sales were up 23% versus prior year or up 29% on a constant currency basis, as the sales mix shifted 600 basis points from prior year to 70% original equipment and 30% aftermarket.

Gross margin increased 70 basis points to 24.3%. The improvement reflects continued traction on the IPD operational plan, as we improve operational excellence, our on-time delivery, the supply chain, and focus on disciplined cost management. Operating margin improved 320 basis points to 10.9% as a result of improved SG&A leverage, increased sales volume and the overall improvement in gross margin due to contract execution.

IPD is realizing the benefits of our 2011 realignment activities, ongoing continuous improvement initiatives, on-time delivery, SG&A expense control, disciplined pricing policies and overall contract execution. I remain confident that we are taking the necessary steps to reach the targeted 14% to 15% operating margin by 2015.

The flow control division had a tough quarterly comparison to prior year. Bookings decreased $29 million to $381 million, down 7% as reported or down 1.1% on a constant currency basis. While most end markets were down, we did see improved bookings in the power industry, resulting from increased aftermarket nuclear activity in Korea and in Europe. Regionally, bookings improved into Europe and more specifically in Russia, as a result of increased distreceting orders, but this improvement was more than offset by declines in the Middle East, Africa and Latin America.

Sales increased $26 million to $395 million, up 7.2% or 14.2% on the constant currency basis versus prior year. Sales growth was driven by original equipment sales in the oil and gas sector, resulting from regional strength in Asia-Pacific, North America, Middle East and Latin America, which more than offset decreased sales into Europe and Africa. Gross margins decreased 30 basis points to 35.4%, due primarily to a shift in product line mix and a mix shift to original equipment. Operating margin was unchanged at 17.3%, although operating income was up 7.1% or up 14.9% on a constant currency basis, due to higher sales and cost control. SG&A as a percentage of sales was down 60 basis points to 18.2%, as we continue to drive operational efficiency in the flow control division.

In summary, we are pleased with our progress of our initiatives in supply chain, on-time delivery, contract execution, and quality improvements, as we drive towards greater operational excellence. Looking forward to our end markets, the oil and gas markets continue to see long-term growth prospects in the upstream, production and transport areas, with large megaprojects in the downstream area shifting to the mid- to the second half of 2013. Power should continue at its current levels over the short-term. The chemical market is beginning to show signs of softening to some degree, while mining appears to be mixed in the short-term, based on concerns about overcapacity and demand brought about by the world economic picture. With that, I would now like to turn it over to Mike Taff.

Thank you, Tom, and good morning, everyone. Over the last several months, I have met with many of you to discuss our earnings risk profile and the benefits derived from our diverse end markets, geographies, and short cycle and long cycle exposures. We view this diversified, lower risk profile as the key differentiator for Flowserve that allows us to confidently make and meet commitments and return value to our shareholders.

As we look at year-to-date bookings, our focus on end-user strategy and our critical application engineering solutions for our customers has enabled us to drive organic growth above market growth. This is evident in our growing bookings despite a challenging macroeconomic environment. Overall, year-to-date bookings increased $109 million, up 3.1% or 8.4% on a constant currency basis. We are pleased with this growth, as we increased our aftermarket capture and grew our installed base above market growth. The increase was driven primarily by the oil and gas and chemical industries, which more than offset decreased bookings within the power industry. When we look at year-to-date sales numbers, the mix shifted 1% in favor of original equipment, which generally carries a lower margin than the aftermarket business and can pressure the margin profile.

Sales increased $178 million over prior year, up 5.5% or 11.2% on a constant currency basis. At the end of last year, we had guided to top line revenue growth of 5% to 7% over 2011 and I am pleased that we are tracking in that range, despite the stronger than expected currency headwinds through the first nine months of the year. Turning to the financial results, sales for the third quarter increased 3.9% year-over-year or almost 11% on a constant currency basis. The sales increase was primarily driven by original equipment sales in IPD and FCD.

Gross margins were down 20 basis points in the third quarter versus 2011, due to a mix shift towards original equipment, partially offset by operational improvements. Similar to the first half of the year, there were approximately 200 basis points of margin impact due to low margin projects flowing through earnings. While we anticipate shipping the majority of the remaining legacy backlog in the fourth quarter, we expect to see margin improvement on increased volume and better fixed cost leverage, which should more than offset this legacy impact. SG&A as a percent of sales in the third quarter decreased 60 basis points to 19.5% over the prior year, primarily due to better cost management.

Operating margins in the third quarter were up 40 basis points to 14.2% on lower SG&A, partially offset by lower gross margin I discussed. As we look at other expense income line, we continue to incur negative currency impacts due to the volatile US dollar. The $0.12 loss below the line is primarily related to balance sheet reevaluations in Mexico, the Euro zone and India. Additionally, the stronger dollar versus the third quarter of 2011 resulted in an above the line translation impact of $0.18. So, on a year-to-date basis, we have experienced $0.85 of currency related headwinds when compared to 2011, with approximately $0.45 above the line and $0.40 below the line. Our effective tax rate for Q3 was 26.1%, which is below our structural rate of 28% to 30%, but was still above last year's unusual low third quarter rate of 22.9%. We continue to expect the full year 2012 rate to be at the lower end of the 28% to 30% range.

Turning to cash flows. We had another strong quarter as we remain focused on improving cash flow conversion. We generated $63 million in operating cash flow in Q3 or $123 million year-to-date, which is a $273 million improvement over prior year. CapEx in the second quarter was $27 million. We have invested $84 million year-to-date and continue to expect capital expenditures to be in the $125 million to $135 million range for the full year. As Mark mentioned, we made progress in the quarter on our long-term capital structure strategy, as we move towards our targeted debt to EBITDA ratio of one to two times.

We issued $500 million of ten year public notes and executed a new $1.25 billion bank credit facility. At the end of the quarter, total debt to EBITDA was 1.2 times. The total financing activity resulted in fees and a write-off of deferred financing costs totaling approximately $1.4 million. This more efficient capital structure will continue to provide us with the flexibility necessary to grow the business organically and through strategic bolt-on acquisitions, with room to return capital to shareholders.

During the quarter we repurchased $101 million of shares, which brought our year-to-date buyback total to $534 million. Our $1 billion share repurchase program has $524 million remaining, which we expect to complete next year. We also returned $18 million to our shareholders in dividends in the third quarter and $56 million year-to-date. I would like to spend some time on how we view allocation of shareholder capital. This slide visually shows the systematic process the management team and our Board contemplates when determining how best to use capital.

We are committed to profitably growing our business, both organically and through strategic bolt-on acquisitions that provide a tight fit and available synergies. However, when making the decision to deploy capital, our larger goal is to allocate capital to the most attractive alternative that provides the highest risk adjusted return to our shareholders over the long-term.

Turning to working capital. Improving our performance and cash conversion metrics remains a priority of mine. Earlier in the year, we engaged a specialized consultant in this area to work with our black belts to evaluate working capital activity at several of our largest sites around the world. The results and recommendations from this work were beneficial and are now being used to drive improvements to the Company's working capital efficiency. In the third quarter, DSO increased three days versus prior year to 85 days. We typically see a slight seasonal increase in DSO in Q3. That said, I still see an attractive opportunity with our disciplined focus on cash collection and the improvements we are making on the front-end bidding process to drive DSO into the mid- 60s over the next nine to 15 months.

As it relates to inventory, turns decreased marginally to 2.7 times versus prior year at 2.8 times. With Tom's focus on on-time delivery, reducing past-due backlog, and cost of quality, we believe we will reach our long-term target of four to 4.5 turns over the next 15 to 21 months. As I have stated previously, working capital is receiving a significant amount of my attention and we will remain committed to this area until we drive these metrics to the targeted levels.

So, as we take a look at the remainder of 2012, we expect strong performance despite the expected negative impact of currency and the planned shipment of the remaining lower margin legacy backlog. We believe increased volume and absorption and the effects of our share repurchase program will more than offset the currency headwinds and legacy projects.

As you know, we have seen significant foreign currency volatility with the strengthening US dollar during the first three quarters versus 2011. We are now estimating a full-year currency headwind of approximately $1.00 to $1.10 versus 2011, slightly higher than the $1 we estimated at the end of Q2 and the $0.50 impact we forecasted at the beginning of the year. This foreign currency headwind should be partially offset by approximately $0.30 of net benefit related to share repurchase activity in 2012, although somewhat offset by higher borrowing costs related to the increased leverage. So, all told, we are narrowing our 2012 EPS guidance range to $8.20 to $8.70.

Finally, I would like to welcome Jay Roueche to the Flowserve team as our Vice President Treasurer and Investor Relations. Most recently Jay served a similar role for McDermott Internationally. I have had the pleasure of working with him in the past and look forward to getting out on the road with him and meeting many of you again soon. With that, I will turn the call back to Mike.

Thanks, Mike. Operator, we are ready to open the line for Q&A.

(Operator Instructions)

Mike Halloran, Robert Baird.

So, on the deferral's and the push outs that you were talking about, could you discuss kind of the end markets that those are the most prevalent in? And how much of it is you are seeing the deferral's already versus expectations for deferral's based on customer commentary and things like that?

I think it's more of the latter in terms of we stay in close contact with these customers. You have seen a lot of these projects, oil and gas, some in the power, even some on the chemical side get booked into the ENCs. But as that process goes along in the feed work and it moves to final bid stage and talking to customers, you can just see they get pushed out a quarter or two.

This is -- we're not in a situation where we were. When we talk about looking forward back in '08 not even close, but it is the same thing you just kind of continue to have the dialogue, you know these things are coming forward, there's been a tremendous amount invested in them and so we just stay in touch with our customers.

And if we would've talk last quarter, maybe the quarter before that you would have said first half next year with some of these larger projects getting let out in the marketplace. It sounds like that's more mid to late next year expectation at this point?

Yes. Coming into last year about this time we were targeting right around the end of this year and then we saw them slip to Q1 and now we've see them slip another quarter.

It make sense.

So, all in all, they have slipped two maybe three quarters since we started looking at these things last year.

That makes a lot of sense. An update on the one Flowserve concept and specifically on some of the cost of quality initiatives that Mike and the team our pushing through with Tom, could you just provide an update there and specifically what the acceptance level looks like in the EPD and IPD pieces where a lot of the focus was being pushed?

Well, if you take a step back in general, these things certainly do take time and that is why I made the comments in my opening comments about work remains to be done. But, I think what you have seen in IPD are some of the early signs of the impact of really Tom's leadership and his team. I think in general if you look across our overall margins and our SG&A, you're starting to see some of the impact of the One Flowserve in that line in terms of fixed cost leverage overall in our business. But, in looking forward, I still think driving through EPD as we get the legacy backlog and start getting the benefit from some of the discipline that they brought in, that is yet to come. Obviously, we see more margin improvement for IPD as well. And then also, if you look back and think around the FCD business starting to be able to leverage some of the capabilities we've seen over in IPD and EPD, that is yet to come as well> There is definitely still work to be done. I think Tom's spent a lot of time with his organization that he laid out for you in the Analyst Day. They are getting a good cadence and getting some good momentum.

Makes sense. Last one for me, then. Just tax rate guidance, low-end of the 28% to 30% range is where I think Mike said it was going to come in for the full year. Is that the -- I guess the question is twofold. One, for the fourth quarter, if you are going to get a full year range in that low-end of that range, it implied something north of 30. So, maybe just clarification whether the fourth quarter guidance on the tax rate is closer to that low-end. And then also, what the appropriate level to think about is as you work through '13, '14 and beyond?

Yes, I would say, Mike, the lower -- for the fourth quarter we'll be at the lower end of the tax range. That 28% to 30% range.

And then for 2013?

We will comment on 2013 in a quarter or so.

Sounds good.

Just remember, a lot of that, Mike, is driven by mix, domestic versus foreign. So, last year when you saw that higher tax rate, that was because we had strong performance in the United States. As we understanding it now, the US is now the highest tax jurisdiction.

Appreciate the help.

Charley Brady, BMO Capital Markets.

Just back on the product push out, I just want to make sure I am clear. The projects, some have been pushed out, is there any of that in the current backlog or bookings now? Or is that just stuff that just has not been let that you thought was going to be let, but now it's pushed out?

Right. It's the latter. It is yet to be booked. So when we talk about, when we are talking about project opportunities, that's remarks around future bookings.

On the EPD business, I know you in the prepared remarks you said the legacy projects impacted margin by about 200 basis points or so. Can you just spell that out just for the EPD business itself, because you obviously had a pretty strong year-over-year flip on the OE aftermarket mix, which sounds like it's being masked. The margin improvement is being masked by this legacy stuff?

Well, I think I will jump in real quick. Mike's comments were most of the impact is in EPD, but there is some in IPD as well, and even the small amount in FCD. If you recall back in late 2010, early 2011, there were quite a few projects, big projects that were let out in the Middle East that were very, very competitive and all three of our units that participated in those. So, that's some of what is coming through. And I'll remind you from my comments on the last earnings call, don't associate these with bad projects, associate them with the time in which they were bid and look forward and think about the aftermarket opportunities that they represent.

On the $1.00 to $1.10 headwinds, obviously $0.15 to $0.25 obviously in the fourth quarter event. Can you split that between how much you are thinking is above versus below the line in Q4?

Charley, I'd say a majority of that is above the line, 80% plus.

One more, I will get back in the queue. On the DSOs driving that to the mid- 60s, if you were to get to that level, when you get to that level, I guess, how much -- can you quantify how much additional cash generation that implies?

It's about $13 million, $14 million a day.

Great. Thanks a lot.

Thanks.

Hamzah Mazari, Credit Suisse.

First question. You talked about the push out of these projects not being similar to 2009. Maybe if you could talk about how investors should view current excess capacity in the marketplace and if you do see these projects maybe continue to get pushed out maybe into early 2014, what you think the impact on the pricing environment could look like?

Well, as you -- our capacity will look multiple years out and we see these project opportunities, as we have talked about before, in infrastructure been available over the next couple of years. That's different if you are referring to back to 2009 as to when we didn't know when the cycle was going to abate. We've been through kind of a lower cycle over the last couple of years and there is need for investment. So, that is how capacity is going to look going forward in terms of the project opportunities. It's not going to -- capacity, especially on a long cycle project, the focus is around 12 to 18 month in terms of being worried about absorption. And if so, if these things push out a quarter or two that's not going to have a significant impact. If the market were to come to a view that it could be over an 18 month period, then on the margin that could start to impact pricing, but we don't see that at this point.

And then just a follow-up question, on the aftermarket side are you beginning to see more customers outsource and maybe talk about what is driving that change from some of these customers doing this in house and just your view there?

I mean, it's a long discussion, but I will try to summarize it. Complexity. Increased complexity. So, the capabilities of customers, local machine shops and everything relative to that complexity is not there. I think the second thing is you do have an aging population of engineers, particularly in the United States, where they are going to be looking to outsource that bandwidth to companies that can address the complexity and be responsive overall in our business. And, then reliability in terms of responsiveness as well. So, those are trends you are seeing in the aftermarket business. And you add to that a lot of our end user strategies. This is moving way beyond where it was 20 years ago in terms of break fix or just providing quick turn parts into efficiency, quality, reliability of these big, big projects. That is becoming increasingly important and so, as you look around the world, installed base is just that. It is there and permanent. And unless they shut it down they always need to seek a way to optimize that capacity. And that is really where our end user strategies are targeted.

Hamzah, I would also add that as we start to see more maintenance monitoring taking place on these large projects in plants, we are going to see more of this trend continuing going forward.

Great. That's helpful. Thank you.

You're welcome.

Scott Graham, Jefferies.

So, I was wondering where you were seeing weakness in chemical? Is that North America and Europe?

Primarily over in Europe. I mean, what you are seeing in Europe, even relative to where we were a year ago, is weakness almost in all of our sectors, as they kind of work through their financial issues and their uncertainty themselves. In the United States, you still have a market, a chemical market that is out there, but we are lapping pretty tough compares. So, was big growth last year in the US chemical industry. So, as we look forward there certainly is softness, but there is opportunities to bid projects. There is one in the Middle East. There's opportunities here in the United States, that are going to give us opportunities going forward.

Could you also give us an update on where some of the Korean EPC's are showing up around the world as you go out and bid?

Well, they bid very actively in the Middle East in '09, '10 '11 and it actually consumed quite a bit of their capacity. So, we don't see them moving as quickly as they did before and you're starting to see that more in the Westerns, now that they are reporting some of their project opportunities. They are still fairly active in the power industry, they have been, we expect they will continue to be.

So for instance, we are seeing some of the Koreans now looking at the UK nuclear market and potentially getting into that market also.

So, the year is tracking pretty much as you guys said from the beginning, which is great. I am just wondering, the fourth quarter guidance is still kind of wide and I am wondering what kind of the thinking is behind the lower end, the things that transpire there versus some of the things that come to fruition on the higher-end. Is it something internal? Is it timing of shipments? Maybe you'd lay that out a little bit for us? Thanks.

I'll summarize real quick. I mean, the big thing is currency. Scott, you saw $0.30 impact in this quarter, 12% below the line/ You saw 17% below the line in the second quarter and there is volatility in our tax rate. I think what you've seen has been pretty consistent in our performance this year is good leverage on our sales in the operating income line.

But, then to that end, since it is -- if it is internal, then if we were to just stay status quo from here on currencies, not that they will of course, but the guidance that Mike provided there on what you guys are expecting for the fourth quarter, does that land you, if it -- things stay status quo does that land you towards the higher-end, toward the lower end, or is that something for right in the middle?

Well, I mean, Scott, we're not going to comment on a precise number there. I mean that's really kind of the purpose of the range. I will note, obviously, that the midpoint did increase $0.05. So, we do feel good about the year. We think Q4 will be a strong quarter as it has traditionally been for the company. But as Mark said, if you ask me what was one of the things that surprised me in Q3 it would've been currency. We certainly weren't forecasting $0.12 below the line, much less $0.18 above the line. So, I'd say the $0.50 range just gives us a little bit of cushion for some potential volatility, not only in the euro but other currencies that we are seeing in Mexico, Latin America, and India and other regions of the world where we operate.

Last question, a simple one. Could you give us the end of quarter share count?

End of quarter fully diluted share count was 51,285. On the face of the 10-Q as of October 23 it was 49.9.

Wait, maybe I'm misunderstanding. You are saying the end of quarter share count versus the face of the 10-Q -- oh, I see, I am sorry, for the optional share. I get it, sorry.

No, no. The Q has to bring down the share count to the date of the filing, which is the beyond the end of the quarter.

Oh, I am sorry. Yes.

Which would have included some share repurchasing activity in the first 23 days of October.

All right. Yes, that's a good clarification. Thanks a lot very much.

Thank you.

Brian Konigsberg for Vertical Research.

Does back to the project slippage's, just trying to get a sense -- I don't know if you said, but where within which markets are exactly are you seeing the slippage's? I think you were insinuating that it was downstream, but I was curious if there was other markets that are showing some of that slippage as well?

And also, on the downstream, particularly in the US, I know some of these petrol chem projects are starting to ADPC. Are people -- I'm just curious the nature of the push out. Is it people reconsidering the economics of these projects? Is it really logistics, because of the size of the projects? If you give just a little more color on that?

I would say, first of all, primarily on the oil and gas side of the business. And even though the long-term trends are looking good, it's more on the refining business then on the upstream production and transportation. The upstream production and transportation business is not where that push out is occurring.

The push out is occurring for a couple different regions -- reason. Just probably got a little bit of a pause going on relative to what is going on with the oil prices worldwide and project financing and a few other issues. But, we're talking about the oil and gas business and on the refining side of the business.

But as we mentioned, we're still confident these things are going to go forward. There's been a tremendous amount invested in them.

Brian, and I would say just spending the last six years plus before coming to Flowserve in the ENC business, that's something we see routinely. So, the ENC's are similar to what you are hearing from ENC's as well. Not unusual for these large multi-billion dollar projects to move to the right as they're just going through their -- the pre-feed and feed activity.

I would say no cause for alarm just wanted to update you on when we thought we would be seeing some of these projects going to market and actually hitting our books. Before we were saying Q1. Now I think what we are saying is Q2, Q3 type timeframe of next year.

And just on EPD you talk about higher selling cost., Maybe just a little color on what that entails and is that expected to continue into Q4 next year?

I think it is more just an investment, primarily around our end-user strategy and some of the aftermarket business we have some investments in and selling cost. And to some extent Lawrence had some selling cost with them being in the consolidated results for a full year.

Can you quantify the amount of headwind you saw in the quarter? And is that expected to continue or no?

It wasn't headwind. I think what he was saying is we had some increased selling cost to support our aftermarket business and our seal business and then also you're just seeing the add of Lawrence pumps in there, too, year over year.

And just lastly for Mike. So, you guys did raise a lot of debt during the quarter, obviously allocating it to buyback. At $1.2 billion are you kind of settled with that debt balance for now? Or, do you anticipate you might have some increase in the next few quarters or so?

Well, I would say we're at the lower end of our target range of 1.2 times debt to EBITDA. As you know we've said we won't operate in that one to two times range. So, we will continue to monitor that. I mean, end of the day, though, as we talked about, we firmly believe that our job is to allocate capital to the most accretive method possible in all. And that's really a decision we will make quarter in and quarter out.

Got you. Thank you very much.

Nathan Jones, Stifel Nicolaus.

Can I just get a clarification on the share count there? You said 51,285 was the end of quarter diluted share count. The 49.9 on the cover is a basic share count correct?

That's correct.

So, I was just making sure you hadn't bought back 1.3 million shares in the last 23 days.

Don't think so.

Okay, cool. And I guess a question for Tom. FCD has had a couple of negative order quarters in a row. I know a fairly large portion of that goes through distribution. Have you seen any impact there from distributor destocking or OEM destocking for that matter?

The distribution business has held up quite nicely in the year-over-year compare and sequentially. I would say that the distribution is one of those businesses that is more prone to more GDP type changes in the marketplace, but it's held up quite nicely. As a matter of fact, on the sale side, the sales distribution business was up very slightly year-over-year.

So, what do you attribute the bookings weakness in FCD then?

We had a very tough compare. We had one of the highest bookings last year at almost $409 million. So, that's one of the reasons. There was some softening on the chemical side of the business, we did have, as I mentioned, some good districting in Russia. We did, again, have some good aftermarket business on the nuclear side and then the oil and gas business on the, let's say, shorter term business was down slightly.

Great, thanks. And Mark, on the balance sheet you're talking about one to two times gross debt to EBITDA, but at the pace you are going to complete this buyback by the second half of next year, you're only going to be spending about as much cash flow as you are generating, if that much, and your net leverage is probably down closer to half a turn or something like that. Isn't it more realistic to focus on what your net leverage is?

I mean, I think you can focus on multiple metrics. I think we chose to focus on the growth metric. But I will tell you that there is a lot of opportunities out there for investments and we continue to monitor those. Inorganic or bolt-on type opportunities out there. We're seeing various deals on a quarterly basis. Obviously, we haven't done anything this year-to-date, but that doesn't mean we won't and all with the right fit, with the right synergies and all. So, as I said before, we'll continue to monitor capital deployment in the most accretive ways.

You know, Nathan, one of the reasons we don't look at it net is there is a frictional element to cash that is overseas.

And I guess, seeing as we're talking about M&A, how is the pipeline looking at the moment?

Well, I mean, we were active out there looking for things that fit. We like things like Lawrence Pumps, that we had last year. It is something we can integrate fairly quickly and provide a return to our shareholders. So, it's good. You've seen some assets change hands in the marketplace and, so, we certainly keep an eye out for things. But what we want to do is make sure we evaluate all these things in terms of what is the best return for shareholders.

If I could just slip one more in, I'm going to see if I can get anything out of you about next year. I understand currency has been a significant drag on the actual dollar bookings numbers. Year-to-date orders are up about 3% over last year and backlog is up about the same amount. Is that 3% order and backlog growth rate kind of the way we should be thinking about an organic revenue growth as a baseline for 2013?

There is a lot of our business that comes in during the current year, particularly as you look at our aftermarket business and some of our shorter cycle business as well. So, it's not necessarily all long lead time type projects that you can use that to map revenue for next year. And some of it, as you look next year, is going to be what the impact of currency is. It could still provide an additional headwind to us next year. But our focus is on, and I made this in my comment, the market growth opportunities that are out there, in general, and how we participate. One of the things that we talked about was we see opportunity in oil and gas, power relatively stable and the chemical market some softness, but with opportunity in there. And then what we do to drive share gain in those particular sectors as well and then the benefit that we expect to see in terms of some of these larger long lead time projects that out there. So, keep in mind if we book a big project towards the end of next year, typically we won't see the revenues until the following year.

But, that's probably the best way to think in terms of our revenue is what our markets are going to provide, driving our aftermarket growth, as you've seen us do up to this point, and focus on share gain. We also have the benefit, we'll get the incremental benefit of Lawrence pumps, growing some of our other acquisitions, some of our product introductions, as well. We've been spending money on R&D. So, what you are getting a very short synopsis of kind of how we go through our planning process and think about how we are going to grow our business next year.

All right, guys, thanks very much.

Robert Barry, UBS.

I saw the comment in the deck about expecting the legacy backlog to be removed as a margin issue in 2013. I mean, just order of magnitude is that about a 200 basis point tailwind?

We've talked about during the course of the year 100 to 200 basis points if we walked through and I think Mike's comments for this quarter were 200. So, it's a good way to think about it.

Just given the way it is tracking would it be fair that the biggest year-over-year Delta from that stress would be kind of weighted to the first half, but where the absence of that stress on the margins?

No, it actually would be more towards the end, because it started out and actually the pace of shipping it has increased during the course of the year. Then also we talked about on the last call some of these things we're waiting on, basically, some supplies from some suppliers. If they don't come in, in the end of the year it could go over into the first-quarter of next year. But for the most part we will have executed on this legacy backlog in 2012.

Another question on margins and EPD. I think there was some mention of higher selling related expenses there.

Right.

I just wanted to drill down on what that was. If that was sales force investments or what it is and how long it's going to stay elevated?

Well, a couple of things. When you talk about these long lead time projects, that are -- we expect to see next year, you have to start building some of the capabilities to support bidding those and executing on those. So that is one area. Another area is we've seen good growth in our seal business and a lot of that is because of the sales force we dedicated to it as well. I think finally in our end user strategies aftermarket, a lot of which is in EPD, we've invested in some resources and including QRCs, folks basically on the ground drive that business as well. And I think the last thing in the SG&A line is just the inclusion of the Lawrence pumps SG&A year-over-year.

And then just a couple of housekeeping items. The interest expense, of course, not surprisingly tracked higher in this quarter. Just for modeling purposes going forward is the 3Q level or maybe a little bit higher kind of level we should be using quarterly?

I think it's pretty fair, about the range we are out for this quarter is directly in line with what you will see kind of in future quarters.

As Mike mentioned, you did have that deal cost in there. Just keep that in mind, Robert.

Sorry, how much is that?

That's $1.4 million. But also you will have a full quarter of the bonds in there as well next quarter. So, kind of I would say directionally where we are for this quarter would be where we will be for Q4 as well.

And then just finally on the repo activity, I think you did just over $100 million this quarter, is that what the expectation would be for fourth quarter as well?

Yes, I think we will be in that. We may be slightly higher. I would say we will be in that 120 to 140 range or so for Q4.

Okay, great. Thank you.

Sid Panda, RBC Markets.

The first question I had was regarding the share buyback. Earlier you had said that it would be completed in a six to 12 month timeframe and now the press release says 2013. So, has there been some moderation in the plan to buyback shares in 2013?

No. I would say no moderation. I mean, we're pretty much right on schedule. We talked about last quarter in the conference call that we would be in the 200 to 240 range for the next six months. This quarter we purchased $101 million. And as I just mentioned, I think next quarter, or Q4, you will see us in the $120 million to $140 million range.

And the next question I had was on the DSO and working capital targets. Could you give some specific examples of steps being taken to reach the DSO goals. You talked about expert being brought in and some steps being implemented. Could you elaborate on that a bit?

I would say overall as it relates to just the working capital project in general, we did have a specialized consultant work with us this quarter with a number of our black belts and go out and visit several of our large site. I would say the results and findings were kind of threefold. One was revising some of our existing processes, implementing some new procedures and also just some cultural issues among the operations and all. I think we addressed those overall. You'll start seeing some improvement. So now, we are going from the assessment phase to the implementation phase. We will start that in the latter part of Q4 and that will carry us through a longer period of time in the next year as we implement these recommendations.

Thank you, that's all.

Thank you.

David Rose, Wedbush securities.

I think virtually everything has been answered. I have two follow-up ones. One, just to be clear, no orders have been canceled? Is that correct?

That's correct.

Okay. Secondly, the cash flow statement implies based on the third-quarter that about $3.7 million was the FX impact on, non-cash FX impact. You had mentioned the balance sheet valuation or the balance sheet valuation as an impact below the line. So, that $3.7 million how much of that was below the line? Or maybe I can rephrase that. On the balance sheet revaluation or the below the line number how much of it was actually a non-cash impact for you?

Below the line, typically when you are marking the balance sheet or any one of your hedges it is non-cash.

Right, so virtually all of it is non-cash?

Think of it is non-cash. David, let me clean something up from earlier. We do have from time to time immaterial cancellations in our projects, they are very, very small.

Okay, so the market hasn't suggested a material change?

No, no, right.

Perfect. I just wanted to clarify that. Okay, so we can look at that-- of the $3.7 million non-cash item then, how would that be divided? Between above the line and below the line?

I'm not sure, David. We'll get back to you on that.

And then lastly on that FX front with new treasurer in place what sort of steps can we see to kind of control that volatility in the below the line number? I mean, can you intimate what you plan to do for next year?

That's a great question. That is something we are going to look at. That's certainly a big challenge we have when you have literally two-thirds of your business that occurs outside of North America. And so we are going to review our overall hedging policies and make sure we are doing everything we can do to preserve all the economic value possible in our business.

Keep in mind, David, these hedges are designed to actually reduce cash flow volatility and cash earnings volatility. The reason the volatility is created is typically the hedged asset is sitting in backlog and you have to mark the hedges every quarter. That's just the rules. So when the accounting rules changed ten years ago to where -- around hedge accounting, you had to start marking your hedges every quarter.

So, what I want to definitely convey is we do, we run these programs to mitigate risk and to basically hedge the economics of a project that can take a year to a year and a half for us to process through and ultimately collect the cash. So, I think there's going to be volatility typically and you see it in other companies as well, as long as you see this tremendous volatility of dollars relative to foreign currencies.

Okay. Great. Thank you.

William Bremer, Maxim group.

You called out on the pipeline business specifically in North America as favorable for not only Lawrence pumps, but your valve division as well. Can you provide some additional color there and really your exposure to underlying pipe, primarily long-haul?

Well, I think what you're seeing is a tremendous amount of investment in midstream. The legacy piping business was typically around natural gas, but increasingly now what you are seeing is increased piping into the liquid parts of the world. That is gas to liquids or actually oil movement around the world, larger storage facilities and this investment, which is installed base on the midstream side, presents opportunities. Really broad-based opportunities in the valve business, to your comment earlier, because whether it's gas or liquid, we have the opportunity on the valve side, but as there's more investment on the liquids, that's where you have rotating equipment.

And then given the midstream going into downstream, which is your bread-and-butter, if these potential projects that you are talking about continually do get pushed out, is it possible may be in a quarter or so if we don't see them really come to fruition, that we do get an announced increased -- announcement on an additional restructuring initiative?

No, we don't want to certainly comment on anything like that at this point in time. What we're doing is we're sitting here thinking about how to invest in our business. We'll always look for ways to improve it, Bill, always in any instance, but what we see right now and we are still confident that these projects are going to move forward.

Okay, that's all I have. Thank you.

Thank you. We have reached the allotted time for the question-and-answer session. I will now turn the call back to Mr. Mike Mullin for closing remarks.

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

Thank you, ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.