福斯 (FLS) 2013 Q3 法說會逐字稿

Welcome to the Flowserve third-quarter 2013 earnings conference call. My name is Paulette, and I will be your operator for today's call. (Operator Instructions)

I will now turn the call over to Jay Roueche, Vice President of IR and treasurer. Please go ahead.

We appreciate you participating in today's call to discuss the financial results of Flowserve Corporation for the third quarter of 2013, which we announced yesterday through our press release and Form 10-Q filing. Joining me on the call this morning are Mark Blinn, Flowserve's President and Chief Executive Officer; Tom Pajonas, Chief Operating Officer; Mike Taff, Chief Financial Officer; and Mike Mullin, our Director of Investor Relations. Following our prepared comments, we will open the call to your questions and instructions will be given at that time.

Before turning to Mark, I would like to remind you that this event is being webcast and an earnings slide presentation is available, both of which are accessible through our website at Flowserve.com in the investor relations section. An audio replay will also be available on our website approximately two hours following the conclusion of the live call. Both the audio replay and the slide presentation will remain on our website for a period of time over the next few weeks.

Finally, please note that today's call and the associated earnings materials contain forward-looking statements that are based upon forecasts, expectations, and other information available to management as of October 25. These statements involve numerous risks and uncertainties, including many that are beyond the Company's control. As such, we encourage you to fully review our Safe Harbor disclosures contained in yesterday's press release and slide presentation, as well as in our filings with the Securities and Exchange Commission for additional information. These documents are also accessible on Flowserve's website under the investor relations section. Finally, please note, except to the extent required by applicable law, Flowserve undertakes no obligation and disclaims any duty to update any of today's forward-looking statements.

I would now like to turn the call over to Mark Blinn, Flowserve's President and Chief Executive Officer, for his prepared remarks.

Thank you, Jay, and good morning, everyone.

I am pleased with the Company's performance in 2013, including our strong third-quarter results. The key factor driving our significant operating and earnings leverage across the business is the commitment of our dedicated employees in executing our initiatives and strategies. Their efforts have prepared the Company for growth.

Our focus over the last 18 months on operational improvements in capital structure efficiency position the Company for upcoming market opportunities. Profitably growing the business and delivering value for our shareholders remain our top priorities. We delivered on these priorities during the quarter. We turned mid-single-digit revenue growth into double-digit increase in operating income, which resulted in a 30% improvement year over year in EPS. In particular, we were encouraged by the strong flow-through to gross margin and operating margin.

Our solid performance and improved operating margins resulted from strong revenue growth in EPD, improved IPD operations, consistent strong performance in FCD, and reduced SG&A in each segment. We again demonstrated the earnings leverage available within our diverse and stable business profile, and the propensity for further operational improvements is significant.

We remain committed to delivering value to our customers and shareholders by focusing on growth, operational excellence in volume leverage, thoughtful cost control, and optimizing our capital structure efficiency, including returning value to our shareholders. We believe this formula of disciplined growth, improving operations, and reduced share count is the key component to our solid year-to-date results in 2013 and provides the foundation for continued earnings leverage over the coming years.

Speaking briefly to our end markets, some uncertainties remain. The world economy is fairly sluggish, and the unpredictable political environment creates delays in investment decisions regarding major long-term infrastructure projects.

Despite these issues, we are encouraged, as Europe has demonstrated stability and signs of improvement. North America has been steady, and good opportunities are ahead on the strength of oil and gas and chemical projects. Macro growth in Asia is expected to continue, and our objective is to increase our presence. Latin America should see increased customer spending over the next few years, assuming currency and political stability, and we continue to believe that Russia and the Middle East will require increased investment to further expand and update their capacity. In fact, we have started to see a few customers proceed with large infrastructure projects; but as expected, they have been very competitive.

Considering large project activity is not yet ramped to the level we anticipate in the near future, we will remain disciplined and selective. We expect that the pace of these opportunities will quicken as evidenced by a number of significant projects awarded to EPCs in the energy space and, in particular, some large chemical projects in the Gulf Coast. These awards and the continued progress of other projects we are tracking are good leading indicators of our OE business.

We were pleased to receive a few medium-size orders during the third quarter, including one project order for approximately $30 million. These awards, in combination with our steady run rate original equipment business, resulted in our highest quarterly level of original equipment bookings since the first quarter of 2012. Our confidence that the cycle is beginning to turn with a low-cost natural gas tailwind continues to build. Backed by solid original equipment orders, we are pleased with our overall third-quarter bookings level, which exceeded $1.2 billion in total. This sum represents a 3.7% increase year over year and is the third sequential quarter of total bookings growth. This quarter's growth was achieved despite a difficult compare period.

As you may recall, the 2012 third-quarter included large bookings in excess of $90 million in IPD. Aftermarket bookings of $479 million remain solid as we continue to execute our global end-user strategies. As discussed previously, many of our refining customers had deferred some of the scheduled maintenance since late last year due to strong margins. However, these deferrals are temporary, and the needed maintenance work will build. So we expect the situation to abate in the future and ultimately return to normal seasonal activity.

Looking briefly at segment performance, EPD's earnings power was demonstrated in the third quarter, with nearly a third of its $84 million revenue increase flowing through to operating income, despite the increased sequential legacy shipments. IPD's operational results continued to deliver year-over-year improvements, increasing gross margins by 120 basis points and delivering operating margins of 11.3%. This trajectory maintains its trend line and remains on pace to achieve the segment's targeted range for operating margins of 14% to 15% by 2015.

FCD, which has had strong and consistent growth in operating performance for many years, delivered its highest gross margin since the first quarter of 2010. The operational excellence demonstrated in this segment reflects the opportunities for all of our businesses.

Looking forward to the 2013 fourth quarter and beyond, we expect to continue building momentum and anticipate growth ahead. With another quarter of solid operating improvement behind us, I remain confident the management team and our employees are focused on the right areas. We are taking the strategic actions needed to capture opportunities within our core markets, operations, cost structure, and existing global footprint. Let me now turn the call over to Tom for his operational review.

Thanks, Mark, and good morning, everyone.

I too am pleased with our third-quarter financial results. This performance is visible evidence of the operating progress we have made. Our disciplined investments in the operating platform are delivering returns. These initiatives including improved quality, project management, aftermarket service capabilities, project pursuit, and sales organization initiatives will position Flowserve to meet or exceed customer expectations and capture opportunities from a strengthening cycle.

Over the last year or so, we have talked about the importance of improving our key metrics and processes. One area where we have made significant progress this quarter is with on-time delivery. During the third quarter, we drove our pass-through backlog below 6%. This is a quarter level not seen since 2009.

In a continuous improvement environment, we recognize that our work is never complete. We still have working capital and cash generation goals to achieve; but with our recent steady improvement of the DSO and on-time delivery it gives me confidence we are pulling the right levers, giving our people the necessary tools to reach our goals will enable a high level of performance going forward.

Our strong operating performance also helped drive impressive gross margin expansion. This increase occurred in spite of a somewhat lower aftermarket percentage. We also generated outstanding flow-through as our focus on controlling costs resulted in lower SG&A across our segments and allowed more of a top line growth to result as income. Sequentially, we also had a sizable increase in the shipments of legacy backlog.

Turning to our order activity, we remain optimistic. Third-quarter bookings were up 3.7% year over year, driven by growth in all regions except Latin America. EPD bookings were the highlight within our segments. EPD increased its total bookings by over 20%, primarily driven by 53% growth in original equipment.

Flowserve's consolidated bookings this quarter once again demonstrated the value of our diverse end markets and regional exposures. For instance, IPD bookings were down on a [tough] compared to last year's third quarter. However, excluding the impact of a group of large orders exceeding $90 million last year at IPD, its bookings would have increased roughly 18% this quarter. Similarly, [FCD's] bookings were down 2% for the 2013 third quarter but, year to date, remains up, a very solid 6.6% for the year.

As Mark discussed, our bookings continue to rely on our reoccurring aftermarket and run rate activity. However, we did win a few medium-size projects in the third quarter. This type of OE work, in combination with the EPC awards we have seen, is a positive sign that the market is nearing a turn. We remain confident that the number of large projects are in the pipeline and expected for release over the next few quarters. I will again emphasize, however, that our approach to bidding will remain disciplined.

Executing on the processes deployed throughout the organization over the last 18 months has proven successful and remains critical to the overall long-term quality of our backlog. Summarizing our end markets, the chemical market remains strong and the outlook is very positive, further buoyed by a recent EPC project award for new ethane capacity in the Gulf Coast. The announced level of North American shale gas-related investments is impressive, valued at over $70 billion. And the majority of this capacity is destined for ethylene or ethylene derivative projects. The Middle East is also continuing their drive towards downstream diversification, while Asia and Latin America are reassessing their chemical development plans.

Turning to oil and gas, current oil prices and the positive long-term outlook clearly support major investments. Significant refinery projects in the Middle East, Asia, and Latin America are expected.

North America continues a strong growth in pipeline construction to address new pipeline capacity requirements, refinery upgrades, and gas processing in gas-to-liquid plants to capitalize on advantaged natural gas and oil supplies. Also in North America, we see a shift in the coming opportunities. Western contractors executing oil and gas projects that will remain here, particularly along the US Gulf Coast, should be an advantageous development for Flowserve, considering our presence in the region.

The expected changes in Mexico allowing foreign participation in its oil and gas production should provide a potential opportunity for us. Additionally, we are pleased that L&G production and export terminals in North America continue the permitting process, which could be another source of growth. In other upstream regions, floating production, storage, and offloading FPSOs, opportunities remain steady in Brazil, Africa, and Asia-Pacific.

Moving to the power market, we see it growing, driven by the fossil-based initiatives in China and India. The Middle East also signals strong future growth, both in conventional and solar power. North America and Europe remain slower due to conservation and low growth and energy demand. Recent EPA rules for coal plants may require carbon capture, which is still in development. Nuclear power remains in transition, although even Japan is considering restarting a number of plants. Additionally, opportunities continue in upgrades, up-rates, and recertification of aging existing plants. Finally, we are seeing an increased focus globally on natural gas-fueled combined cycle plants.

Our general industries markets continue to see high activity levels in global fertilizer projects. Mining companies are investing more carefully of late, while good levels continue in parts of southern Africa, Latin America, and North America. The desalinization market is also displaying encouraging signs, as industry experts expect new plant orders increasing over the next few years. Finally, our distribution business, primarily valves, was very solid. This activity largely derived from orders supporting global oil and gas projects.

Wrapping up, our operational progress over the last year and a half is significant. However, I am equally encouraged by the propensity of the organization to continue this momentum and capitalize on additional opportunities. We look to finish the year strong, and I am confident that our improved operating platform and solid backlog have us well positioned to deliver on our full-year commitments and set the foundation for the future.

With that overview, let me now turn it over to Mike Taff.

Thank you, Tom, and good morning, everyone.

Mark and Tom have pretty well covered our operational overview and business outlook, so I will quickly discuss our financial results in greater detail. While Flowserve's value proposition is much more than any individual quarter, we are pleased with our reported results and continue to gain momentum. We generated strong leverage off solid revenue growth of 5.4% on a reported basis and 6.4% on a constant currency. This brought our year-to-date constant currency revenue growth to 4.9%, which is right in the middle of our 2013 revenue growth target range of 4% to 6%. Our OE to aftermarket sales mix this quarter shifted one percentage point to 62% OE versus last year, which pressured gross margins.

Looking at margins, as we indicated last call, we expected third-quarter gross margin pressure in EPD, which occurred as we shipped a sizable amount of previously delayed legacy backlog. Offsetting this and the lower aftermarket sales were strong gross margin performance in IPD and FCD, which together enabled impressive gross margin improvement of 100 basis points. This improvement demonstrates the impact of our bidding discipline and selectivity. It also reflects the solid operational improvements that Tom discussed.

Turning to SG&A, we drove a reduction of absolute dollar spend in each segment excluding corporate. This resulted in a decrease of 70 basis points in consolidated SG&A as a percentage of sales and was driven by disciplined, thoughtful cost control, and solid leverage, notably in EPD. We continue to focus on our longer-term goal of driving additional leverage from this expense as we target SG&A as a percentage of sales to be consistently in the 18% range. The initiatives we are currently executing, combined with a growing top line, should keep us on pace to deliver on this commitment in the coming years.

The strong leverage in our business was demonstrated, again this quarter, with a 16.7% increase in operating income coming off the 5.4% reported revenue growth. Operating margins increased an impressive 150 basis points to 15.7%, primarily driven by the 220- and 210-basis point increases in EPD and FCB, respectively. We continue to believe we are on pace to achieve our consolidated operating margin objective of a 100- to 200-basis point improvement by 2014, off of year-end 2012 levels, as well as IPD's targeted operating margin goal of 14% to 15% by 2015.

For the second consecutive quarter, we saw a relatively calm foreign exchange environment. As such, we experienced minimal impact from the sequential mark to market of our currency hedges and our balance sheet items in nonfunctional currencies. Our tax rate for the quarter was 30.6%, and we anticipate this 31% level for the fourth quarter.

Turning to cash flows, we delivered solid improvement year over year and sequentially. Flowserve generated $142 million from our operations during the 2013 third quarter. Capital expenditures were $34 million, and we repurchased $64 million of our shares. At quarter end, we have $473 million remaining under our current buyback authorization. We will continue to execute on our strategy to efficiently deploy capital to the most accretive long-term alternatives, including organic and acquisitive growth and returning capital to our shareholders. As in prior years, we expect to generate a significant portion of our full-year operating cash flow in the fourth quarter. Additionally, we continue to focus on working capital initiatives to address identified opportunities for improvement. Our goal remains to consistently generate annual free cash flow near our net income level.

Turning to primary working capital, we produced some improvement in the 2013 third quarter year over year with a reduction in DSO by five days. This builds upon the progress we made in the second quarter, with a year-over-year improvement of three days in that quarter. Inventory return remains essentially flat with the 2012 third quarter. However, we were especially pleased with the significant progress on our goal to reduce past-due backlog, achieving a quarter end level not seen since 2009. These steady improvements in our DSO, combined with the reductions in past-due backlog, provide confidence that we are progressing towards our working capital goals of mid-60s DSO and inventory returns of 4 to 4.5 times.

Looking ahead to our EPS guidance outlook, we are raising the low end of our 2013 guidance range to $3.33 from $3.20 per share and leaving the upper band at $3.53 per share. Our confidence in this move follows our strong year-to-date results, as well as our continuing operational improvements and solid performance of the run rate in aftermarket businesses.

Similar to last year, our full-year share repurchase activity may impact average share counts such that full-year EPS could be slightly lower than the sum of the four individual quarters. Considering we are near the midpoint of our organic sales growth guidance, we left the 4% to 6% range unchanged on a neutral FX basis.

Turning to our spending priorities, as I mentioned earlier, we will continue to return value to our shareholders and remain committed to deploying cash to the most accretive long-term alternatives, including bolt-on acquisitions. Importantly, we will invest in our business to deliver profitable growth and solid organic returns, forecasting 2013 CapEx of $120 million to $130 million to further increase our worldwide capabilities. Other uses of cash we expect this year include pinching contributions and scheduled debt repayments, but these amounts remain fairly modest in comparison to the other priorities.

In the fourth quarter, we amended, upsized, and extended our senior credit facility. We very much appreciate our banking partners' ongoing commitment to Flowserve and look forward to working with them over the coming years. With this amendment, we will have under $1 million of non-cash expense in the fourth quarter, but we expect rapid payback on this investment. We believe our capital allocation approach, with a targeted debt to EBITDA between 1 and 2 times, provides the flexibility to grow the business organically, return capital to shareholders, and invest in strategic bolt-ons and will continue to produce solid returns for shareholders.

What that, I will turn it back over to Jay.

(Operator Instructions) Hamzah Mazari, Credit Suisse.

Good morning. Thank you. The first question is just -- you know on some of these larger projects, Mark, could you maybe comment on how you plan on balancing taking on lower-margin OE work with the potential of potentially getting the lucrative aftermarket revenue stream from that versus just completely walking away from some of these projects?

Well, I mean, that is an essential part of our sales and operation process when we look at project opportunities. So to give you an example, on two different types of projects, on a water project where we know there won't be a lot of aftermarket attachment, we've got to get our economics in the original equipment bid. If you look at a project like we did in the Middle East, the [Onbu] one which was very competitive, had little economics on the OE side, we are going to build a QRC near that facility and be able to harvest the aftermarket for years. So our process is designed to look at the long-term economics -- we look at it almost like investing in a bond. We look for the type of returns you are going to get over the horizon of your investment, keeping in mind some of these investments will be out there for 20 and 30 years.

That is very helpful. And then any comments on the uptick you saw in EPD bookings? Specifically, just your thoughts around these medium-sized projects beginning to hit versus some of the larger projects that maybe some of your competitors have said have gotten pushed out a bit?

Some of these mediums were part of very large facilities. We were just very laser focused in terms of type of projects that we took on them. But the uptick is just that; it is the early stages of what you are seeing in the project opportunities that are out there. So this is typically the way a cycle goes through. The big projects never come as quickly as you would like, but what you start to see are some of the longer lead time, more complicated type products that get put out -- they tend to be smaller orders -- and then you move into the other stages of the projects. So it's definitely a good leading indicator as we look at project opportunities over the horizon.

Great. And just the last one for me, I'll turn it over. On the M&A landscape, any thought process there? You guys been out of the market for a while. Has anything changed there?

No, and we haven't been out of the market. We've actually -- you haven't seen anything, we've been fairly disciplined, but we are actively looking at opportunities for growth. Keeping in mind with the opportunities we have organically, we're going to remain disciplined and selective in terms of what assets we take on and how quickly we can lever them. What we look for is something that we can lever on our platform pretty quickly. If you look at Flowserve, we have a very expansive platform, broad product set, and what we want to be able to do is really take this and drive quick revenue growth and margin improvement when we bring an asset in. We don't want to spend a tremendous amount of time with complex, multi-year integration.

Great. Thank you, thanks a lot.

Scott Graham, Jefferies.

Good morning. Nice quarter. This is a question more for Tom than anyone. When the projects that you are referring to and have been referring to for a while finally start to get released by the OEs on to the EPCs, where do you think that happens first? I am assuming your thinking there is kind of broad-based but maybe more tilted toward North America. Are you thinking it's going to be more tilted towards chemical? Just give us an idea of how you see the sequencing of this.

Well, if you take a look at some of the large projects, we are having some good activity now down in the Gulf Coast. You've seen some of the recent EPC announcements there on some of the ethylene business on the chemical side. So my expectation is that some of the larger projects, we'll begin to see in the US. There is also some good L&G activity with the permitting process going on as we look at exporting out of the US. I would say you're going to probably see some of that, and we've already seen some early indications with some of the EPC announcements.

I would also indicate that the FPSO activity has been good around the world, particularly in Brazil and some of the other areas. Combined cycle power plants, we're seeing a pick-up there. And I would say pick-up is certainly in the Asian region, the Middle East. And we've seen a lot of activity now in that area now starting to come into the US, particularly since the US coal market is going through some changes at this point in time. So I would say that the chemical market in particular, you will see the projects -- see it on combined cycle power plants, certainly the FPSOs. And (inaudible) what I would say, Scott.

Great. This is a question now for Mark. The increase in your footprint that you are referring to in some of the emerging markets, could you give us a little bit more on what you meant by that? I assume you're talking QRCs, but I mean -- headcount, where is it going, when is it coming?

No, it's actually manufacturing facilities so that we can bring product to market in those locations. So in China, we are actually building our third manufacturing facility there. It'll be complete -- we're actually opening it next month. And in Coimbatore, we're going to open our third block of manufacturing in that area. So we'll have multiple facilities. The significance of that in terms of growth, Scott, is that that's how you access those markets as you -- with local manufacturing and local sourcing. So when we think about how we enter into an emerging market, the first thing we think about is how we're going to migrate products over into that market. You've got to create the manufacturing to do that because it only lets you import for so long; and also you need to be competitive.

So what that means in terms of this capacity there, first and foremost, is it's going to give us more penetration, a better competitive footprint in those markets to grow the business there. We've got a lot of opportunity in China in terms of being able to grow that business. And then ultimately, these facilities -- a secondary benefit is they help support our operations around the world in terms of LPO, SPO so that we can drive our manufacturing costs down.

Okay. So it's nothing incremental versus what you guys have been doing. I guess I thought that you meant something new and on the board for QRCs. You're not saying that?

No. These are manufacturing facilities that I was referring to. And the term is must-be-present-to-win in these regions of the world; and we are expanding our presence, not only physically but in terms of the products that we offer in those markets as well. Now, on the QRC front, those are very much driven by where the capacity that needs either fiscal capacity support or human support, and that's where we basically will put those resources. But when you are looking over in Asia, you're talking about Malaysia and certain parts -- the region there, even Vietnam, where they need support, we have been adding QRCs in those regions.

Got it. Last question, this is kind of back to Tom, and you and I talked about this at the analyst meeting. You guys continue to show this resilience in your power business that is not really been seen certainly on the manufacturing side -- or the generation aside, I should say -- by others.

You alluded just now to -- at the end of your comments that the US business -- you're kind of seeing what everyone else is kind of weak. What are you guys doing differently today, or is it just that your footprint is able to garner new business? But you guys have been outperforming that market now for probably two years, I would say. What is it that you are doing there that is really enabling that?

Scott, I think the number one thing is that we've got a very diversified portfolio, not only of products but of assets on the ground, in order to service those markets locally. So I would say that that's one of the biggest things.

The other thing I would say is that we have been active, obviously, in India and China, and that coal market is still doing pretty good there. The nuclear market -- we've maintained, as we've discussed before, all of our certifications over the years, even though that market has been going through some changes. So as those revamps and upgrades have now switched on the nuclear side from all the new builds that they were going to do, maybe through those revamps and upgrades, re-certifications, we are right there with our assets to be able to do that.

The solar market -- we are still seeing the solar market be active in Spain and Africa, and obviously we have facilities there.

And then lastly, even though the coal market is going to some changes on a worldwide basis, we're seeing some aftermarket pressures certainly in the US on that. We see a pick-up on combined cycle power plants coming because of the low cost of natural gas. So I would say it's the diversification of our assets and products and some movements in the markets, as I've indicated.

So Scott, one thing to add on, if you look at one of our presentations from a couple of years ago, we said our business is linked with global secular trends around population growth. With the broad product opportunity around the world, what it allows us to do is to tilt into those secular trends as opposed to what may be a more episodic trend.

Makes sense. Thank you for your time.

Mike Halloran, Robert W. Baird.

So first on the margin line, obviously a really strong performance there. Could you just talk about your view on the sustainability at these levels? Particularly EPD, FCD, where there's some very strong leverage that you saw in the quarter. And anything that suggests that on a forward basis this isn't a pretty good base to build off of?

You know me, Mike, I won't guide specifically on margins. But go back to our statement that we made at the beginning of this year around propensity in our business. I think an important message here, not only in terms of what you are seeing in the financials, but our ability to compete for opportunities going forward as the platform is improving. And so what you are saying, particularly in EPD, is that we've seen some of the facilities start to execute better. Not all of them. Some of the facilities are starting execute better, which helps them penetrate the customers better; and then you add to that good fixed costs leverage on the SG&A line, and that's what drives margins. So despite the fact that gross margins have decreased, we get good operating leverage on SG&A, and that's the way that business is.

Keep in mind, if you take a step back and think about where a lot of the costs in a long project are embedded in cost of sales in the gross margin line, because you allocated to the specific project.

Turning to IPD, what we are pleased with is that we saw a gross margin improvement, which is reflective of the improving operations. It didn't get the fixed cost leverage because on the sales side, that was expected. Our priority with IPD has been improving the platform. Because if you grow business when the platform isn't ready for it, it's tough. You let your customers down. We've seen that movie. So now what we're focused on in IPD is driving growth in that business so that we can continue to get the operational leverage in the gross margin line but start to cascade it on the G&A line; they've been very good with costs.

And then on the FPD line, I think the way to think about that business is, as I mentioned, that business has been performing at what we think is a very high level for a number of years. It's had the benefit of processes that we are putting in place across the Company for many years, and that is why you see it operate so strong.

So that's probably the way to think about the business. And then overall, the last remaining thing in the PNLs, if you look at, in a sense, the corporate line is that we just need to be disciplined and diligent, as we have over the couple of years, of controlling corporate costs. Those are things we have direct line of sight to and are within our control.

(multiple speakers) But I think back to, Mike, the question we had earlier -- the improving platform and the margin power that we can deliver does help us participate at good levels in the project opportunities that are going to start coming up. Now, we will remain disciplined because you live with this backlog for a long time. If you think about it, the duration in our backlog last year to this year has decreased significantly, and the economics has improved substantially.

That makes sense. That was the color I was looking for there. And then two related questions. One, what does the utilization look like now through the portfolio, at least generally? And then second, when you think about the throughput and the operational improvement initiatives you guys are pushing forward in the platform, you obviously said it's stickier in some places than others. How far down the road would you characterize the process is today?

Well, we're all -- especially with the capacity that we're adding, we're always looking at how we optimize our capacity at a holistic level. And we will always continue to do that. And that may be, what products do we put into some of our mature market facilities that we can leverage the LPL/SPO strategy? So we are adding product capabilities through R&D and development. We also look at, as we've done, we consistently are looking for how we improve it on those facilities. I think, in terms of the operational improvement, we still have probably two or three years to go to get where we expect this Company to be.

That's great. And then the last one is, could you just talk a little bit about industry pricing dynamics? How much stability you're seeing there? Obviously, internally, you're doing a lot better job of being more selective. But how does the landscape look beyond just what Flowserve is doing?

I think, as I mentioned, there's the external and the internal. The external is you anticipate with these projects -- the first one to come out tend to be competitive. Because, as we've had this discussion, everybody's anxious to see these, and they want to grab them when these opportunities come out. So that's the external force.

What will happen, though, is over time with the cadence of the projects as they come, they tend to become less competitive -- they are still competitive. And they were competitive in 2008 as well; I'm not suggesting they're not. I think the internal thing is equally important, our ability to compete. There's still a lot of leverage we're pulling in this business to make sure we can drive our efficiency to much higher levels, which enables us to certainly compete better. And I think that's a good example when I went back to IPD. Getting that platform improved helps them compete better, and it's the same thing in EPD as well. What we've seen is the good consistent performance in FCD has enabled them to really compete well and respond well and drive growth.

So those are the aspects of competition. We are operating our business, if it's going to remain competitive, because good competitors out there -- what we see in a lot of the competitors that you are certainly familiar with is, I think, they are driving discipline as well. A lot of things we've been talking about, we hear them talking about as well, which is not a bad sign for our industry. But these first projects will tend to be competitive.

Brian Konigsberg, Vertical Research.

I just want to touch on EPD, specifically on the OE part of the business. I guess the one thing that really kind of stuck out to me today was how strong the OE sales were in the quarter, and you did have very strong orders in the quarter as well. But kind of looking over the past year, I mean, the order profile has not been that strong. I always kind of sense EPD being a fairly long-cycle business, 12 to 18 months from order to delivery. And so the Q3 results really does not reflect that type of pattern. I'm just curious, is there a shorter cycle complexion to the business that maybe I'm just missing? If you could touch on that, that would be helpful.

Over half it's sales for aftermarket. So we need to always remember that. That is a very, very short-cycle business. So you have seen that consistent growth in the aftermarket. And while it's not double-digit order growth and sales growth year-over-year, it is very high margin, so has great contribution to the gross margin and to the operating margin line.

I was specifically referring to the OE part of the business, though. Kind of comparing the trailing 12-month sales order profile versus what you did in sales in the quarter on -- specifically on OE. It just does not jive with what we've seen historic -- jive with the patterns on the order front. And I always got the perception that it was a long-cycle business, so the performance you had a year ago would be showing up today.

Well, a couple of things. The duration of their backlog, as we've moved it out, has certainly shortened. So fair to say that the long-cycle nature, as we have taken some of these legacy projects out, has certainly become shorter. They do have some shorter OE -- run rate OE business, absolutely, in the business. But I think that's part of what you are seeing is the -- and now some of these medium-size projects come in in the order book.

So I think as you look at that, the long-cycle nature of that business is working through the cycle going back to five years ago. They were heavily loaded with long-cycle backlog coming into 2009 and 2010. It was high-priced. That carried them and their margins for a number of years. Then they were still a long-cycle business at that point in time, but it was -- the economics were significantly different from the 2008 time period backlog; and that is starting to run through as well.

We had quite a bit of that in the backlog last year. So that is starting to run through right now. With their improved execution and some of the opportunities that we are saying, they are starting to fill that backlog back up. The difference is, it is better quality, has better economics, and we are executing on it better. That answer your question?

Yeah, but just kind of looking -- maybe taking a step further. I know you don't want to give 2014 guidance, but kind of looking at the order trends in the first half of 2013 on the OE side, you are down between 10% and 15%. Conceptually, are we thinking that the EPD, OE sales could kind of level out over the next 12 months, even though your order profile continues to improve?

You're right, I don't want to give guidance, but I think you've hit on an important trend. We were sitting here in the fourth quarter of last year -- and if you look at the prior three quarters of sequential bookings, they were down. And go from that point now, you look over the last three quarters, sequential bookings have generally been up. And the same thing is in EPD as well. That's a good sign for sales growth opportunities in the future. But you're right, I don't -- we don't want to get ahead of ourselves. We typically put out guidance right at the beginning of the year.

Charley Brady, BMO Capital Markets.

Let's talk about IPD for a second. You touched on this a little bit in a prior question, or answer to a prior question, about the growth platform, but -- I mean, you're talking about it on a 300- or 400-basis points upside over the next couple of years from where we are coming out of Q3. And I'm just wondering if you can maybe -- what are the growth initiatives that get you to that kind of -- what is significant upside in the margins over a relatively short period of time?

The number one initiative is, and continues to be, improving execution. A lot of the IPD business is short cycle, and if you can't take care of your customer well, they will go somewhere else. So that has definitely been the number one. We wanted to get this thing improved before we started to grow it; that was a priority. Now we're turning our sights definitely to growth. So when we look at the opportunities -- product development, one of the areas that we expect to see growth in is -- remember we talked about the [ISO chemical pump]?

Some other product development areas -- one of the questions earlier was on inorganic opportunities; some of the assets out there you see could fit into this segment fairly well. But the key is going to be around execution because if you respond very quickly to a customer, they need it, and you can actually get some pricing power in doing that. So it is, and has been, around execution. We have actually, in a sense, given up some growth to prioritize execution over the last couple years, but I think now we are in a good position to drive it.

Okay. And just to one of your points on the inorganic growth opportunities. So as you look out into that pipeline, are you saying that there are acquisition opportunities where the margin profile of those potential deals would be margin-accretive to IPD when you roll them in?

Well, that is a good premise. We look across, really, many of our segments in terms of -- in many of our business platforms, so we just don't isolated to one. I was just responding to your specific question about IPD. But that is absolutely the case.

What we want to do is -- margin accretion is important and everything like that, but our primary premise on looking at an acquisition is getting an internal rate of return. And generally we like 15% or greater, which ultimately should correlate to margins over period of time. But as you know, sometimes, certainly with purchase price accounting, it takes a lot to get there. But we look in terms of internal rate of return in the business. And so what we wouldn't want to do in IPD is something that we think has good margin improvement opportunities, is to pass it up just because it won't get us the margins we need next quarter. That would be playing it too short-term.

Okay. And if we just look at IPD for a second and a little bit back on the prior question about the OE orders, which were up pretty strong. And I apologize if you covered this already, can you give us a sense of kind of end market, where those are coming out of and duration of the OE orders you took in the third quarter?

Sure. The concept of run rate business, and we talked about a medium-sized order, really correlates to duration. So it's fair to say that you compare year-end backlog to where we are right now, the duration is shorter. Especially as we move some of what we call legacy in past due backlog through the system, which, I can assure you, had very little economics to it. So the point to that is, we are still in what I would call more of a shorter duration-type booking environment. But we will expect the longer ones to start coming in.

I would also add on the EPD side, just looking at some of the industries -- the chemical bookings, we are very strong; the oil and gas bookings, we are also up. We had the power bookings. If you take a look at -- we actually had -- the power bookings were up because of some de-sale projects that we were working on.

And then if you look at the regions, with the exception of Latin America, all the other regions were also up in the business. And the other good thing on the large projects is that we are also seeing some good feed and pre-feed activity on the large projects.

So we are continuing with that trend with the EPCs that are in there with the feed work. We're also seeing now some of that feed work result in bidding opportunities where the EPCs are now winning those larger projects and going into the bidding stage, particularly in the oil and gas as well as in the power stage.

Jamie Sullivan, RBC Capital Markets.

Question on refinery maintenance. You mentioned that that's been deferred out. In a typical cycle like this when margins are strong for them, when would you usually see that come back? Is that sort of a next-year event when you would see that activity pick up?

Well, I mean, there's -- weather, especially in the Gulf Coast region, isn't a factor like you would see in other areas where they have to do their maintenance during -- like in the power industry, they have to do it in the cool spring or in the fall. But basically, what you see in this industry is when margins expand out, they want to refine as much as they can because -- and that's their opportunity. And so what they'll try to do is push out the times where they ultimately have to take it down. They can only go so far because the highest cost to them is if something goes wrong, if something breaks down in the facility. So -- and again, what you've see right now with oil costs had come down a little bit, especially in the Midwest, that's going to push their margins up a little bit. So they'll continue to try to push this maintenance as long as they can, but it is really going to be more site-specific. There's certain critical points where they won't go past in terms of maintenance because then they run the risk that the facility shuts down on them. But in general, what you see is when refining margins gap out, spend will get deferred. And we've been living with that for a couple of quarters now. As Tom mentioned, on some of what you've actually seen, we've been able to grow our aftermarket bookings despite the fact that some of the US fossil power plants had been shut down.

Right, thanks. And then on SG&A, I know your target for 2015 is in the 18% range, I think. You're getting great leverage there. Is the 18% sort of a long-term run rate for the model? Are you starting to see more structural leverage maybe from some of the initiatives you've been putting in place over the last year or two?

I think, in general, what you've seen to this point is a shift -- not a change, but a shift in the culture. And these things take time. It can often be humbling in these roles to know that some of the changes you make take years to do. So we've seen some of that, I think, really getting down into some of the initiatives. We will start having these opportunities over the next couple years.

But it's really reflective, we think, of driving a change in the culture, executing some initiatives, but investing in the business. Companies can drive these things down to very, very low levels if they are willing to compromise some opportunities -- some high-return investment opportunities in the future. We don't want to do that. So when we look at that objective, we took into consideration the change in the culture; driving some initiatives; the benefit of One Flowserve, which helps us leverage our G&A; but also, where we wanted to invest.

Thanks. And one last one on cash flows. They showed some improvement there in DSOs. Can you maybe give us more details on how you've been implementing those improvements so far? What we might look for over the next two or three quarters in terms of implementation, process, or milestones? And maybe if you could add some color on the inventory turn side, specifically with OE starting to pick up and how we should think about that.

Hey, Jamie, it's Mike. I think we're pretty pleased. Again, I think, as Mark said, it's certainly a shift in the culture. And we're not there; we're in the implementation stage. As you know, last year we spent a lot of time assessing the situation, and so now it's implementation. And so, as I've said before, the easy part has been completed, which is the assessment. So now we know we need to do, and now we're in the implementation. But it's a big network; we've got a lot of locations out there. I think you'll see incremental improvement, and that's why we set long-term goals. Probably a little bit behind where I thought we would be probably a year and a half ago when I set these targets, but I do see some of the culture starting to shift. And I see the importance that both the financial organization and, importantly, [Tom Troop], the operational organization, is putting on on working capital and managing that working capital. So that's really what it's all about. It's process and procedure and culture changes that we are doing, both on the receivable side as well as the inventory management side. We're getting guys in from all parts of Tom's operations involved both on the procurement side and doing a better job of longtime procurement. We are getting project management folks involved on that as well. So it's really throughout the organization. So I don't think you'll see a sea change quarter to quarter, but what we're hoping to see is incremental improvement quarter to quarter over the next year and a half or so.

Steven Fisher, UBS.

It's certainly a nicely executed quarter and orders picking up a little bit. Just wondering what is your base-case assumption around when you would see book to bill for the Company start to more notably expand beyond one time? Is that literally Q4, Q1, or is it more kind of a mid-to later 2014?

Steve, nice to meet you. I think we met you one time before. We don't go -- being not a quarter-to-quarter business, we don't go specifically and give book-to-bill or any kind of bookings guidance in the business. I think if -- just to help you understand the growth opportunity in our business, frankly, if you look at the backlog at the end of 2011, it was higher than the backlog at the end of 2012. And yet, we've been able to grow revenue this year. This is the issue of the duration of the backlog -- how long it is in there and how long it takes you to roll through your P&L on the revenue side. So a lot of our backlog now has a shorter duration, shorter cycle, and we are pleased with the earnings trends over the last three quarters. So it's a good way to think about our business.

And when we start booking these projects, especially the big ones, we do take some POC revenue on some of them, so you get the benefit of some of them as they start to come through. But they'll tend to hang in your backlog a lot longer. That's why we've been so focused on growth of our run rate business and our aftermarket business. So hopefully that can help you think about how we think about growth overall in this business.

I think from an earnings standpoint, what we don't want anybody to underestimate is our contribution rate of an incremental dollar revenue to the gross margin into the operating line as well -- gross profit and operating line as well. So with the improving operations, with our cost controls, we are able to drive growth in our earnings. This year, it's been multiples of what you see in the revenue line. So hopefully that helps you think through this in our business because what -- the duration of the backlog is how quickly it'll convert into revenues.

That's very helpful. And in terms of just understanding lead times a little bit better as you reference some of the US-Gulf coast petrochemical awards that of already been made it to EPC companies, when do those start to hit your order books or those of your competitors?

We'll, it depends -- in the competitive landscape, it depends on the lead times required for the products. So there are some products in a large refinery, some gas compressors, which have a much longer lead time and some of our products as well. Even within our product spectrum, we have different lead times. Often, we've talked about the valves tend to be some of the shorter lead times in these. So it's really going to be dependent on the products relative to our industry. The complex equipment tends to be earlier on in the project as they require long lead times in manufacturing.

Having said that, what we've been focused on, and this was my comment earlier about our ability to compete and respond, as we saw it happen in the pipeline industry in 2011 -- and, frankly, we didn't fully participate to the level we wanted to because of lead times -- the shorter lead time on the margin got you the project, even with some pricing power. So we're taking the approach that we are not going to rely on lead times in and of themselves to take care of our business; we are going to drive for the shortest lead times possible to be responsive.

I will now turn the call back over to Jay Roueche for closing comments.

Thanks, Paulette. Again, we very much appreciate everyone for participating in today's call and for your interest in Flowserve. If you have any follow-up questions, please don't hesitate to call Mike Mullin or myself. And, operator, we've now concluded today's call, and thank you.

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