福斯 (FLS) 2014 Q3 法說會逐字稿

Welcome to the Flowserve Q3 2014 earnings conference call. My name is Christine and I will be your operator for today's call. (Operator Instructions). I will now turn the call over to Mr. Jay Roueche, Vice President, Treasurer, Investor Relations. You may begin.

Thank you, operator, and good morning, everyone. We appreciate your participation today as we discussed Flowserve Corporation's financial results for the third quarter of 2014, which we announced yesterday afternoon in 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, Executive Vice President and Chief Operating Officer; and Mike Taff, Senior Vice President and Chief Financial Officer. Following our prepared comments we will open the call to your questions and instructions will be given at that time.

Before turning the call over to Mark, let me remind you that this event is being webcast and a slide presentation is available. An audio replay will also be accessible approximately two hours following the conclusion of this live call.

Please note that this call and associated earnings material contain forward-looking statements that are based on forecasts, expectations, and other information available to management as of October 24, 2014. These statements involve numerous risks and uncertainties including many that are beyond the Company's control. And 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.

We encourage you to fully review our Safe Harbor disclosures contained in yesterday's press release, slide presentation, and our Form 10-Q as well as other filings with the Securities and Exchange Commission for additional information. All of these documents including the live webcast and replay are accessible on our website at Flowserve.com in the Investor Relations section.

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

Thank you, Jay, and good morning, everyone. Overall I am pleased with the results we delivered this quarter and our earnings of $0.93 per share. Our employees remain focused on the customer, the products and services we deliver, And their dedication and commitment drove improved margins and higher earnings year over year even as revenues were relatively flat on a constant currency basis.

A number of factors impacted the current macro environment in the third quarter, increasing global uncertainty. While our execution has continued to improve many of our customers are being deliberate when accepting shipment, as some of the products are not on the critical path to project completion.

This impacted revenues in the third quarter by keeping the finished product in our facilities and inventory and represent a continuation of what we saw in the second quarter. While this is a revenue timing issue for us it may persist as we begin the project cycle.

Additionally, revenues for the third quarter were also impacted by a stronger dollar. Despite less than expected revenues, I am pleased we have delivered gross margin and EPS improvement this quarter which demonstrates the benefit of our operational improvements, aftermarket franchise, and the potential for cost leverage with growth.

A key highlight in supporting our positive outlook was another quarter of solid bookings including an 8% increase in aftermarket bookings. Additionally, our year-to-date backlog is up 10.4% or 14% on a constant currency basis, with a year-to-date book to bill of 1.1 times.

Another key strength remains Flowserve's diverse market and regional exposures. We again realized strong activity levels in North America particularly within oil and gas which more than offset challenges in our power markets and certain emerging regions.

While emerging regions can be volatile, as we have recently experienced in parts of Latin America, Asia, Russia, and the Middle East, they remain an important and profitable component of our strategic platform, and we will continue to pursue disciplined growth in these parts of the world. Long-term, we expect continued regional investment in new infrastructure and increased aftermarket services which is why we remain committed to these markets.

In North America oil and gas and chemical investment continued in our mid and downstream markets even as customers pulled back from certain upstream investments. Although oil prices have been declining of late, as many of you are aware, Flowserve's oil and gas focus on a global basis is primarily away from the wellhead and rather in mid and downstream infrastructure. In these markets short-term oil price volatility historically has had less of an impact as lower feedstock costs can benefit refineries and other process infrastructure.

The associated increased hydrocarbon production also requires more midstream investment which is particularly true in North America. We don't claim to be totally immune as oil and gas CapEx spend can be impacted at some price, but we do believe Flowserve is well positioned in the current environment.

Looking at a global power market our bookings in this industry declined 11% year to date as it continues to be inconsistent and lumpy with regulatory uncertainty. But we continue to expect that the world will require additional generation capacity over the long term and our capabilities will serve that market well.

Europe remains an important overall geography for us, returning to stability over the last year. And the region produced bookings growth of over 10% year to date. We continue to monitor the economic indicators in this region but recognize a sizable installed base exists and that our customers intend to keep those assets performing.

For the year, Latin America has been a challenge compared to our expectations with year-to-date bookings down about 3.6%. During the third quarter some Latin American customers continued to invest despite political and financial headwinds which supported 5.7% bookings growth for the region. Over the long term we see Mexico's decision to open their markets to foreign investment as a positive development, and perhaps Venezuela's foreign financial agreements will also support further investment in the region. But we continue to actively monitor and respond to the rapidly changing developments in Latin America.

Asia remained our most challenging region with bookings down roughly 8% for the year as customers we evaluate investments due to slowing growth in the region and the impact of North American shale related to investments versus their local alternatives. Long term, Asia still represents an opportunity for Flowserve as we expand our overall presence to capture additional market share.

From an operating perspective our performance was strong demonstrated by the third consecutive quarter of 35%-plus growth margins. This consistent execution is a result of our strategic initiatives that we began several years ago including One Flowserve, project discipline, focusing on the customer, and tight cost control, which ultimately delivers profitable growth and improving shareholder value.

Our progress in these areas has been substantial, and we believe this culture is becoming embedded and sustainable across our platforms. While we are about halfway through this journey and continuous improvement efforts will never end, we are now increasing our focus on growth including accelerated organic investments in products, markets, and regions that deliver appropriate returns; strategic acquisitions; and at the same time we are pursuing initiatives to improve the returns from our asset base through increased manufacturing optimization, capacity alignment, and improved cost absorption.

As we look at the fourth quarter into 2015 and beyond, I am encouraged by our profitable growth prospects driven by our demonstrated level of operational excellence and growing backlog, and further, the level of bids and proposal requests from our customers supporting the expected increase in activity in our core energy markets.

In summary, Flowserve is performing well. We entered 2014 encouraged by the sign to global growth but near-term uncertainty has crept up during the last few months. However, as we look forward, we are encouraged in our ability to deliver growth and continue to believe the long-term secular trends remain very much intact.

We have a stable operating platform and intend to deliver organic growth as well as opportunistically pursuing M&A. We have capacity in our facilities for significant growth and opportunities for realignment.

Finally, we will not take our eye off the ball as we have initiatives for additional operational improvements. Together we expect this formula will deliver meaningful long-term value to Flowserve shareholders.

So with that overview, I will turn the call over to Tom.

Thanks, Mark, and good morning, everyone. I am also very proud of the progress we have made and our long-term strategies of operational excellence and customer focus, which are becoming sustainable improvements in our culture. Our employees have embraced these initiatives over the last few years, and the results they have driven our significant. At roughly halfway through the process we envisioned several years ago, we remain encouraged by the additional identified opportunities to further improve our performance and better serve our customers.

The Company has demonstrated improvements in all key measures of operating performance including margin expansion, on-time delivery, past-due backlog, and cost of poor quality. This process progress provides confidence that our strategies, customer focus, and prioritized investments in areas such as quality and project management have the Flowserve engine performing at a high level and well positioned for expected growth -- be it organic or through acquisition.

We will continue to pursue additional opportunities to further align our global asset base to drive even higher efficiency, utilization, and rates of return. The strong margin performance we have delivered highlights our ability to generate earnings despite a relatively flat top-line environment. IPD's notable improvement included a 220 and 250 basis point increase in gross margin and operating margins, respectively, excluding the impact of a discrete non-cash charge.

While macro uncertainty may challenge our markets, we continue to expect growth and intend to leverage it through our stronger platform. This quarter's gross margin improvement, which included strong aftermarket shipments and the benefit of our consistent disciplined focus on building a quality backlog, generated a 30 basis point improvement in operating margins on continued tight SG&A cost management.

Our bookings highlight the quarter and indicate expected growth to come. Consolidated bookings increased 5% on a constant currency basis led by an 8.1% increase in aftermarket bookings and continued solid run rate OE activity even as most larger projects remain on the horizon.

Last quarter's strong original equipment bookings of in EPD and IPD turned relatively flat this quarter for both segments. This simply reflects the lumpiness in orders we often experienced. As expected FCD's third-quarter year-over-year bookings improved following the second quarters year-over-year decline increasing 5% driven primarily by strengthening the oil and gas market. Excluding we divested Naval business from a compared period, FCD's bookings improved 8%.

Turning to our end-markets, oil and gas was the primary driver of our bookings increase with third-quarter growth over 18%. The recent decline in oil prices and the forecasted reduction in near-term global growth rates have added some uncertainty into near-term investment from certain customers. However, we believe upstream investment is at greater risk with scrutiny within this context and Flowserve's exposure is more mid-and downstream focused. We continue to expect significant North America activity driven by pipeline construction, refinery updates, gas processing, and gas-to-liquid plants.

We also expect new refinery investments to incur in the Middle East, Latin America, and Asia including clean fuel initiatives. However, some of these investments may challenge the current European refinery market. Europe is, however, expected to increase its diesel production. Brazil is proceeding with further FPSO development. Longer term, Mexico should present increased opportunities following the recent policy reform intended to increase production levels.

From an oil and gas market aftermarket standpoint, activity in the Gulf coast continued the first half-year trend with increased bookings growth compared to levels we saw in recent years. In the chemical market, bookings decreased 1.7% in the third quarter following the strong first half of the year. New capacity projects in North America continue to advance including ethylene and ethylene derivative projects driven by the low feedstock costs in the United States.

While the majority of new chemical investments still expected to occur in developing regions, the chemical production capacity in the US is forecast to increase 30% in the next decade. In the Middle East, downstream expansion efforts continue. Meanwhile Asia and Latin America are reassessing their chemical development plans based on slower economic growth and competing opportunities in the US while some European capacity is expected to convert to utilize US ethane.

The power market continues to be our most challenged served industry given the current slower growth environment and the ongoing regulatory uncertainty. Longer term, we still believe that new generation is required. China, India, and Russia are indicating they will pursue fossil-based projects and parts of Europe are even investing in fossil-based projects and as certain countries retreat from nuclear power. The Middle East also sees increasing needs, both in conventional and solar power. North America and Europe, however, remain slower in aggregate due largely to conservation, the lack of a consistent energy policy, and modest energy demand drivers.

The low price of natural gas and recently announced CO2 reduction guidelines, however, should continue to drive the US combined cycle market subject to adequate pipeline capacity. Nuclear power remains in transition but China, Russia, and South Korea see continued development, and there are discussions of new capacity in some regions of Europe. Following its new safety standards, Japan is closer to restarting a portion of its nuclear capacity which has been idle since 2011.

Finally, natural gas combined cycle plants remain a global opportunity.

Wrapping up, we continue to expect significant investments in our key energy markets even as recent increased macroeconomic uncertainty and forecasts for slower growth could further impact the timing of project awards. However, the level of bids and proposals at the current time is encouraging. Whatever the ultimate timing of these investments, I am confident that we have made progress necessary over the last few years that will differentiate Flowserve through superior execution capabilities, increased capacity, and flexibility to adjust to our customers' requirements and changing market conditions.

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

Thank you, Tom. Good morning, everyone. With Mark and Tom covering our operations and business outlook, I will discuss our financial results in greater detail. Our strong operating performance delivered a $0.03 increase to EPS in the quarter to $0.93 per share in spite of a $25 million reported revenue decline. Adjusting for currency effects and the impact of the sale of Naval in the first quarter revenues were essentially flat.

Similar to the second quarter we continue to experience elevated customer directed shipment delays during the third quarter which limited our ability to recognize additional revenues from products that were prepared to ship. As many of you are aware, the US dollar strengthened sharply versus the euro and other currencies in September. At this level, it would present a translation headwind to our reported fourth-quarter revenues.

Gross margins were again impressive this quarter at 35% and demonstrated our ongoing operational excellence, the improved quality of our backlog, and the mix benefit of strong aftermarket shipments. Year-to-date aftermarket bookings were up 7.2% through September and we have now achieved our fourth consecutive quarter of over $500 million in aftermarket bookings.

SG&A expense declined modestly in the quarter and is down year to date as focused cost control remains a priority. However, we continue to make important investments in SG&A at the same time. In areas such as R&D, quality, and project management resources, to name a few, with revenue increases we expect to effectively leverage these costs; and therefore, we remain committed to our long-term goal of SG&A as a percentage of sales in the 18% range.

Operating margins increased again this quarter with a 30 basis point improvement to 16%. This level is near the high end of our previously announced three-year margin improvement guidance of 15.2% to 16.2% by the end of this year. Additionally, IPD continued its steady progress towards its targeted 14% to 15% range by the end of next year even as it was impacted by a $3.5 million non-cash discrete charge this quarter.

Below the operating line, other income came in at $5.6 million, up almost $4 million from a year ago primarily due to revaluation of net US dollar and US dollar peg balances around the world.

Our tax rate for the quarter was roughly 29%, slightly better than our guidance rate of approximately 30% driven by higher than expected foreign income.

Turning to cash flows, we generated $137 million from operations during the third quarter, which increased our year-to-date operating cash flow improvement to $17 million compared to last year. Consistent with our normal seasonality, we expect a significant portion of our cash flow to be generated in the fourth quarter. Our long-term goal means to consistently generate annual free cash flow near the net income level.

During the quarter share repurchases and dividends used about $57 million of cash as we continue to return capital to our shareholders. Other spending included capital expenditures of about $30 million, and we repaid $10 million of term debt. Working capital remains a key area focus but progress is slower than desired.

Certain Latin America customers continue to delay payments. Their balances are not in dispute, but this persistent practice has negatively impacted our DSO. We are monitoring the situation and taking a number of actions, but significant improvement will continue to take time and effort.

Inventory balances increased from December 31 due in large part to our growing backlog but are down compared to a year ago. As such, we made modest progress in the quarter increasing turns 2.8 times from 2.7 times last year. This improvement reflects our focus on on-time delivery and achieving our fourth consecutive quarter with past-due backlog of below 5%.

Moving to our outlook, we expect another solid fourth quarter reflecting our normal seasonality. As is typical at this time of year we have narrowed our earnings guidance to reflect our year-to-date results. For 2014 we have tightened the EPS target range to $3.65 to $3.85 per share, still within the original range. This range now suggests a 7% to 13% year over year EPS increase.

From a revenue perspective we now expect that line item to be essentially flat on a constant currency basis for the year due in large part to the recent challenges in predicting the timing of revenue recognition, primarily the result of customer-driven delays. The good news looking ahead is our backlog has increased over 10% year to date and top-line opportunities are still there, but predicting the exact timing has shifted somewhat beyond our sole control.

Turning to our capital priorities, as mentioned earlier, we continued to return value to our shareholders and remain committed to our disciplined approach to capital deployment, which includes organic and inorganic opportunities. With our operating platform performing so well, we feel opportunistic growth investments will provide solid returns for shareholders.

We also continue to invest in our core existing business, furthering our capabilities in emerging regions and supporting our aftermarket strategies to deliver profitable growth. One such example is a new initiative recently approved by our Board to further expand and consolidate our valve activities in China.

In summary, the business has performed exceptionally well during this pause in top-line growth. We have successfully delivered solid earnings, increased our backlog in a disciplined manner, and positioned the Company to pursue organic and inorganic growth opportunities.

With that, I'll turn the call over to Jay.

Thanks, Mike. Operator, we have now concluded this morning's prepared remarks and would like to open up our call to any questions.

(Operator Instructions)

Charley Brady, BMO Capital.

Thanks. Good morning, guys. Mark, could we just get into a little more detail on the shipments? Can you maybe give some more granularity on the magnitude in Q4 and kind of the timing of the delays you are seeing? Are you seeing an acceleration in the duration of the timing on those delays?

I think generally the way to look at it is as we brought our past-due backlog down over the last couple of years and improved execution, our projects are no longer on the critical path and often times the customer isn't ready for it. At that part of the project they certainly don't want the piece of equipment sitting outside in the elements for a period of time. So that's the environment we are in right now. So what you see is it can push from the end of the month, the end of the quarter into the next month. We saw that in the second quarter, and I think in the second quarter it was roughly about $70 million that we anticipated or roughly about $100 million this quarter.

I think it's important to note, Charley, that during these times this can in a sense persist -- especially for the right reason in that we are executing well in the equipment is available and it should be. This can be the way these projects go. These are long-cycle projects, they take time. We are a piece of it; we are not necessarily the long leadtime piece of the equipment. As you can imagine, put in a complex pump -- the piping have to be ready, the engineers have to be ready. There is lot of factors. Kind of goes back to why we are not a quarter-to-quarter business. It takes years to build these facilities.

So I think just the important thing to keep in mind is these things aren't going out of backlog. These things are not getting canceled because a project is well on its way, but since we are not on the critical path, which is good news for us, these things can slip for that period of time. And that's in a sense of what we have seen really during the course of this year.

Is that slip -- are you seeing mostly 30-day slippages or 90-day slippages?

You know, it will go project by project. There are some that we probably shipped within a couple of weeks after the end of the quarter, because remember the project -- the big complex project, there's no magic to September 30. So some of those may have shipped a little bit afterwards, some of them may take some more time and even slip over a couple of quarters. Again, if you see the size and the nature of these projects, I don't want to suggest that all these things shipped on October 1, because they didn't.

How much -- one more and I'll get back in queue. On the backlog, how much if any of that backlog extends beyond 12 months?

You know usually we have a year-end disclosure, Charley, and I think on the engineered equipment about 85% -- depends on the lead times and the environment we are in -- but let's say 80% to 90% of that will typically ship in the subsequent year or be counted in the percentage of completion. Keep in mind on a long leadtime project that is sizable, you may not -- what you will be seen is percentage of completion come through as we build the cost associated with that project, but in fact some of the equipment can take 40 to 50 weeks and those are the planned delivery times. Go back to where we were in 2008 and 2009, that was an environment we were quoting 70 weeks -- the market was at that point. But typically a lot of stuff goes within the year.

Mike Halloran, Robert W. Baird.

So kind of sticking on the project side, you know you are at a very healthy absolute level on the order side, and yet you still talking about these delays -- something that we've been dealing with it while now. When you look out there what does it take to reinvigorate this -- to actually have people say it's time to get these either from the EPC backlogs into the supplier backlog or more aggressively start moving things through the channel?

I think what we'll need to drive this I think more steady-state and more predictable from our standpoint is a little less volatility around the world, because on the margin that will cause folks to delay a decision. The other thing that will drive these things coming to market quicker is if there is a big spike in commodity costs or underlying costs like you saw in 2007, 2008. Otherwise what you will see is -- absent those you will see steady as she goes in terms of how they allocate resources but those things can impact it on the margin. So if you see all of a sudden the economy starting to heat up, they will pull these things to market for fear that what happened a number of years ago where the budgets on these go up quickly.

I don't see the situation like we saw in 2009 where the market is going to go into price discovery mode because there has been a quick rundown in the all commodity costs. You remember oil, I think, went down to $40 a barrel at that point in time. So a shock to the system one way or the other can impact it.

The other thing is going to be I would say country specific. So whatever the political environment is in that point in time. What you've seen in Brazil is there was a lot of investment and then the new president came in, they kind of put their foot on the brakes. Now there may be a pro-business leader that comes in at that point in time that may drive more spend. The fact is they do need to monetize those reserves.

The flipside is what you saw in Mexico which is they realized they needed to get external investment to drive that more and more, and we've seen a pickup there.

In Russia what you've seen is some political turmoil, and you are well aware of what has occurred.

So, Mike, it is going to be country specific. But I think the point is in terms of the reason we look at these secular spends out there is a lot of these economies are highly dependent on the price on oil and oil production and price has a component to that, as you are seeing in the market right now. But still production is going to be key to these markets.

The independent oil companies look a little differently. I think what you've seen is a scaled back a lot on their upstream investment and returned to shareholders, right, the sovereign companies -- their shareholders are the government. Those are the kind of things that can impact decisions. So it's different, absent some broad shock in the system that we saw in 2009 or a broad impact that we saw in 2007, 2008 with commodity prices coming up.

That's fair. And then the second one is when you look at the quoting activity out there and you look at the stuff that is in your feed, how much visibility the you have into your success in those pieces? I'm assuming that well before an order is actually finalized that you've got a good sense of what Flowserve's odds are on that particular order. So maybe you could just talk about the visibility and maybe talk about the win rate you are seeing and things that haven't yet been booked and are coming through the pipeline?

We do monitor all those metrics carefully. And a lot of it -- in terms of your ability to predict success are the specifications -- do you have the capabilities? Do you have superior capabilities relative to maybe some of the other competition? Can you support the equipment afterwards over a period of time? Do you have a good installed base there? But I can tell you, Mike, on a lot of these large projects it's still the environment at the end of the day where it can come down to price. So we can be moving to the close on some of these things, and if somebody comes in -- a competitor comes in and drops the price that can certainly impact it.

So I don't want to suggest that we know for certain as we go into these projects because it still a competitive market. That is the way the engineering contracting firms want it.

Having said that, the other things that I mentioned certainly give us visibility. We also think that our ability to execute and respond -- that's so critical. Providing a quality product on time is really at the end of the day some of the cheapest equipment that a customer can buy. But we do monitor it, I can tell you -- we look at win rates, we look at bid activity, we look at our customer relationships. And I think what we are trying to tell you -- what has been encouraging is the improvement in the operating platform. And that gives us I think better access to our customers and a lot more flexibility in terms of how we approach these markets.

Andrew Kaplowitz, Barclays.

Mark, so we've had four quarters in a row of over $500 million in aftermarket bookings. Do you feel comfortable that at this point you've established a new base? That about $500 million. And given the current global economic environment, can you maintain the mid-to high single digit aftermarket bookings growth that you have had over the last couple of quarters?

Well be like the absolute amount, to your point. And if you look over five years I think we've grown this business from about $1.6 billion to now approaching $2.1 billion. And that's through a downturn in global economies, competitive environment, uncertainty. We've seen oil dip down. We've seen refinery capacity become available. We've seen all kinds of things -- regulation. And the point is it's been a steady growth over that period of time. You know as well as I do over the long-term is we hope we continue to grow this business -- we are going to be lapping even larger numbers but the fact is we will also be putting more resources in.

Some of the things that we've look that in terms of growing our business are even investing more in our aftermarket capabilities. So I don't want to guide on an absolute basis what our percentage growth rate will be, but rather point to the fact that we have steadily grown this business, and we still think we have a lot of opportunity to capture installed base which we are not taking care of. Also the ability to put more quick response centers, field techs, service techs at or near all of our customers. To build out the infrastructure in some of the emerging parts of the world where we really don't have that type of presence that we do in parts of Europe and the Gulf Coast region. That's what encourages in terms of aftermarket growth.

Okay, Mark, that's helpful. And then maybe if I can ask you a different question on backlog, backlog is up as you said 10% -- over 10% year to date, which is significantly better than it was at this time last year. But revenue is currently flattish, as you said, and I know you don't want to guide to 2015, but how comfortable are you that as we go over the next year or so we should see a decent acceleration in revenue growth from today's levels?

Well it really does come down to -- the question earlier -- most of the backlog that we have in any period of time will execute within a 12-month period. So if at any compared period you see increased backlog, that's one of your best indicators in terms of just the base level of amount of backlog -- what can contribute to revenue growth.

The other thing to take a look at is what are the trends in the book to bill and year-over-year bookings growth? Which you have seen the growth and good book to bill year-to-date. Obviously that feeds into increased backlog, but if that's the trend over rolling periods what that indicates to you is that it can contribute to increasing backlog at various points in time.

I think the third one is looking at growth in the aftermarket business. High-margin, high-profit business -- quick turn. That will tend to turn over a shorter period of time. That's what will drive growth.

Scott Graham, Jefferies.

My conversations with your guys last night -- I just wanted -- a couple of points of clarity. The push out of this $70 million to $80 million of revenue to push out, my understanding is that was all short cycle, not project.

Those are various things. There could be some shorter things and then some projects. Those are typically projects.

Typically projects, so not short cycle?

Well, some run rate businesses but -- and even honestly, Scott, some aftermarkets that have spilled over a couple of weeks during that period of time. But typically the ones that really kind of get pushed out are some of the run rates that are going into big upgrades and revamps or some of, what I would say, new builds -- those have tended to slip. Because they just don't need a product that that point in time.

Right. On the recapture of this, I'm assuming that none of this is canceled -- it's in fact what you are saying is a push out. If you had to hazard a guess on this, particularly considering that some of it is short cycle, would you think that maybe half of that gets shipped in the fourth quarter?

Half of it could, and then another half could slip into the first quarter of next year.

I'm with you on that. I guess what some of the questions were about, and appropriately so, is that last quarter kind of seemed like $40 million, this quarter more like $80 million. Kind of -- we are trying to connect the dots there and see maybe why your tone is maybe not a little bit more pessimistic, because you still seem pretty upbeat on these large process project cycle.

Well, let me tell you first and foremost why I am encouraged and you, Scott, you followed us and I have known you for 10 years. I mean, the operating platform that we have right now, as I said, has improved so much it gives us a tremendous amount of optionality in terms of penetrating additional customers, growing our business -- all types of things that we can do. I think that's more of the optimism you are hearing than anything else, and also we do look at current bidding activity. To the question earlier, I wish we would win every bid that we get, but we don't. But we monitor the bidding activity and it has been good, which is encouraging.

These things have been on the drawing board for a period of time, and we knew they were going to come to market, and we do certainly see the bidding activity that's out there. I think that's what's been encouraging.

If you look back over this year the one thing that we obviously wish would've been better would have been on the revenue side. We certainly have seen -- we had a divestiture, the impact of some currency which we can't control. But in this environment we see these things move on but they don't go away. They do remain in backlog. So I think in generally we are encouraged because I think -- or I know that a lot of the things that we have in our control we've improved on or had the opportunity to improve on.

These macro environments around the world and foreign-currency and things we can't control, but they do provide opportunities for us. Keep in mind as the dollar strengthens some of our non-US sites certainly become more competitive globally.

Steven Fisher, UBS.

Great. Thanks. Good morning. Not to beat this topic down too much but wondering if you could just talk a little bit more about why the customers are delaying the deliveries? I know you mentioned not wanting to have things out in the elements. But is it other parts of the supply chain that are not performing or is it more the customer is trying to slow things down for either macro reasons or cost reasons?

No, when these things for this for a long there is no benefit in slowing things down. Time is money on these projects. And it could be the rest of the supply base, but I think, moreover, it's no project goes to the exact period of time that it's expected to -- or often times they don't.

And I think the more important thing from our perspective is if you monitored our past two backlogs, it's come down significantly. What we've done is taken our equipment off the critical path. So to your point, they may be dealing with another supplier who may be late are not. It is a contingency to when they put our equipment in. But in general when there's -- by the time our equipment is ready to be delivered there has been a substantial amount of investment in the project, and there is no benefit in letting that project linger for extended periods of time to anybody.

Okay. That's helpful.

And just to add with what Mark was saying these customer shifts could take the form of a change that the customer is making to a project late in the quarter, so the customer could ask for a performance change due to their process or their engineering. Several of these are related to inspection delays where we have planned inspections where the customer's inspectors are coming to a site looking at the product which is all ready to go and they have delayed for a day or delayed it for a week or so on and so forth. Some of those are related to customers that don't need the shipment, as Mark has mentioned, because their schedule may have been elongated or we are ready to ship much earlier than what they needed for the product to get on site and for them to start construction. So there's a whole host of reasons within that biggest customer shift category that Mark has mentioned.

And Steve I'll just say -- again going back to this, these are large complex projects. And we have always tried to maintain we are not a quarter-to-quarter business and they are certainly not a quarter-to-quarter project. But that gives you a flavor. What we don't want to suggest -- I think everybody gets concerned is that these revenues are going to go away like in the retail industry. They don't.

Okay. That's helpful. And just trying to think about how much more runway you have for margin improvement from your operational initiatives given you still have a couple of years left, and I think based on some of the targets maybe 100 to 200 basis points from here. So first I guess is that correct? And then to what extent are you finding some new areas of improvement to address?

Well, in general what we don't want to is we have guidance out there to the end of the year and we certainly don't want to spike the ball before the end of the game. But as you can see we've made very good progress. We do have the opportunity for a margin improvement going forward. I think that will obviously something to talk about going forward as we look at -- what I would say is the next steps in this business. And I think will be try to communicate is we spent the last three years heads down, focused on improving our operations. We are not done, but what we've done is we've brought it to the point now where we can start dialing up our organic growth opportunities and investing for growth and taking advantage of some opportunities we have to even drive more efficiency in our manufacturing platform.

All of those things, as you can see -- growth we are going to get leverage in our business. Driving efficiency will contribute to the gross margin line and the operating margin line. We'll get cost leverage in our business. Growing our aftermarket business and even doubling down on that will help with the margins as well.

So what I'm trying to do is pieced together something that we will continue to talk about as we look forward where we think we can drive growth and margin opportunity in our business. But we still want to get to where we told you we were going to be. I mean, IPD is not there yet; it's made great progress. I think folks were a little skeptical at points in time, but look at the progress they have made. And we're within the 150 to 250 -- actually kind of towards the high end but, as I said, we've got one quarter to go to the end of the year, and we feel pretty good about things.

Chase Jacobson, William Blair.

Good morning. I just wanted to kind of ask about that cost optimization again. Going back to the analyst meeting it sounded like you were mostly complete with the cost initiatives and you were moving on to more internal investment for growth. And, Mark, in your prepared comments we talked about accelerating the internal investment, but you also talked about more room for cost improvements, et cetera. Just curious as to if this is the result of a change in the growth expectations based on what we've seen over the last few quarters, including the delays and just the macro volatility, or if this is just more of finding areas in your business to improve?

Actually, that is exactly the message we wanted to make sure you didn't take away from this. No, it's not that we have any concerns over growth. Go back to my comment originally -- when you are in a strong up-cycle you are doing everything you can to deliver to your customers. When things turned down as they did in 2009 and 2010, you are trying to drive costs out but it's fairly inefficient. And as you are trying to improve your business the last thing you want to do is consolidating or rationalizing capacity because that will impact your execution. It's -- you don't want to do those things simultaneously unless you are in a big post-acquisition mode.

So what we see with a more stable platform is the opportunity -- especially since we have added a lot in the emerging parts of the world -- is start to drive more efficiency in some of our capacity around the world. That's what a smooth operating platform offers to us. We have plenty of capacity to deal with growth and, in fact, some of those activities ultimately hold capacity on an execution basis neutral or increase it. So what you are saying is a level of confidence in our operating platform which we believe gives us the opportunity to do some things that really drive long-term value in our business.

And I would add to what Mark has to say that over time the business will transition through looking at various things to work on cost. So initially it may be lower hanging fruit -- opportunities on the supply chain side. It may be Six Sigma quality initiatives initially. As we now move through our cycle over the last several years, we have some different opportunities coming up, like Mark mentioned, in terms of manufacturing optimization, manufacturing efficiency, taking a look at our wide network to determine how to optimize that network for the highest gross margin in the business, as we look at the lead product organization, the secondary product organization. So I look at this as just a natural transition that an organization goes through as it looks at gross margin improvement over time.

Okay. That's helpful. Thank you. And the other question is just on working capital. I guess for Mike, you've had these targets out there for a while -- you're making progress, has been slower than on the margin side. Are you changing the way that you are approaching the working capital improvements at all? If there's anything that you can point to kind of help us see how you are going to move quicker in the direction towards your targets, that would be helpful. Thanks.

No, Chase, I mean I would say not changing anything. I think we've reached some different phases. Obviously we went through -- it's kind of been a three-phased approach as I've looked at it. Kind of an assessment phase and then we developed tools, and now we are in an implementation phase. And we are right in the middle of that implementation phase which will take over the next -- I'd say -- 12 to 18 months to get it fully implemented.

So, we are still 18 to 24 months away from fully achieving those goals and getting it spread throughout the whole organization. But I do think we've reached the important phase of implementing new tools and process and procedures. It's just going to take time to get it implemented throughout the whole organization. We've got 220-plus locations that generate revenues and where we have to manage inventory and drive better collections. But I think the tools we created, as well as the process and procedures, will serve us well down the road.

Andrew Obin, Merrill Lynch.

Just a follow-up on cash flow. So you noted that some of your customers sort of -- I don't know how to put it -- don't like to pay on time or are not particularly nice to you when it comes to working capital. So when you talk about free cash flow improvement going forward, are you going to change how you do business with these specific customers or these guys will basically remain a permanent drag on free cash flow because they are large and that's how they do business and you are just going to get paid towards the tail end of the cycle?

These things kind of ebb and flow by various customers. The most important thing is you just determine creditworthiness and some of them tend to pay lower. I can tell you the sovereign state-owned entities tend to be slower than the independent. So if there is mix shift -- part of going to the emerging parts of the world is they do tend to pay slower. There can be anything short term with those customers that can cause them to drag things out. So what I will tell you is, I think we will always have some element of this overall in our business in terms of dealing with some sovereigns that will pay when they are ready to.

And, Andy, I think the important thing, too, is certainly we price that in, too. We've got to understand what those payment terms and work hard to negotiate better terms and conditions which include payment terms. But also understanding when that comes in and make sure that's priced into our bids.

And I would add on the working capital side that in several instances a lot of it is related to maybe documentation. A lot of it is related to issue resolution that goes through a particular process itself and, as a result, some of the customers get a little bit stickier with their cash. So in regards to your question, are we starting to do things differently with the customers? I would say absolutely yes. Making it very systemic deep into the organization with good clean purchase orders, good schedules with defined documentation steps. When we get into a problem we try to resolve the problem quickly and getting the customer to acknowledge the resolution of that problem when it gets done. All those things we've found are also ingredients of a good working capital program.

Can I step back and ask a bigger picture question? Every day I am getting calls from investors telling us that the energy cycle is over, oil is going to $70, positive correlation between oil and downstream spend -- not much I can tell them because we are not really going to find out as to what's going to happen for the next six to nine months with these big schedules.

But what I want to ask you guys, what really stood out about your business model back during the downturn is the resiliency of the business model and lack of cyclicality for what is perceived to be a very cyclical business. And the pushback I get is well this was the time when Flowserve was really changing its business model, and if something similar happens today, the business model is just not going to be as resilient in terms of earning sustainability. What do you guys say about that? Sort of the performance of the business model during a shock period as the Company stands today?

I'll just say that the business model worked in a shock that's far more than anybody is considering at this point in time. Going to the price of oil -- let me just kind of take a step back, remember there was a bigger shock a number of years ago and investment continues. Why? If you look at it right now, right now where you see the price of oil it's more of a supply issue than it is a demand issue. Nobody is saying that there is permanent demand destruction; that the Chinese are no longer buying more cars, urbanizing; there's no need for hydrocarbons anymore. What you see right now is more of a supply issue.

So when you look on the upstream side you see where people are moderating their investment for a period of time. Not 30 years because there's no perception that demand is going to go away. But over the short term they may moderate it. Now, that will typically be, as I described earlier, the independent oil companies. When you look at the sovereigns, when you look at the government-owned entities, as I mentioned earlier, production is correlated to their economies. Some very highly correlated -- somewhat notably correlated.

You start moving downstream -- if you think about the key around supply, as I mentioned earlier, transportation is not there, particularly in the United States. Look at all the production we've had in at the well site and yet we can't get it to market. We need more transportation and storage which will support more midstream investment. And then if you go further on the downstream side there's a number of factors there. None of us buy a barrel of oil and put it in our car or put it in an airplane. So the fact is as long as there is commercial demand out there, you are going to need downstream processing capabilities to serve those markets, because the real value in a barrel of oil is the ability to turn it into something that somebody is going to use.

The other thing to think about is people could have called the ball on natural gas a couple of years ago down at $2 to $3 and saying that's going to go away. Well, what was the knock-on effect there? The knock-on effect was they were starting to use that as a low-cost feedstock and driving to the processing side. So processing is really going to be driven by the downstream by demand, which again nobody is indicating is going away. Demand for varying products. Demand also for varying costs of feedstocks and the availability of feedstocks. Also there's an independent element to that. I'm reasonably confident that the United States will never shut down all their refining capacity because then they would be at the mercy of some other country.

So if you think about it, I don't think anybody has indicated that the 10-, 20-, 30-year demand for energy in the secular spend is going away. But on the margin maybe some upstream investment might be moderated some. We still think that's good opportunity, long term. But it creates other opportunities out there, and a great example is going back to 2009 and 2010. While it was competitive there was still a lot of infrastructure that was built on the heels of a significant global shock.

So hopefully that helps on oil. Everybody gets focused on the price of oil and to your point, a comment about our resilience -- I don't know what's different about our Company as opposed to when we went through a severe cycle other than our aftermarket capability and presence is bigger. Our footprint is bigger to even take advantage of more local market opportunities that are out there. Our product offering is broader -- not only just to the oil and gas, but to the knock-on chemical business -- other things that are there. And the other thing that I can tell you -- as opposed to five years ago or four years ago is installed base out there is now four or five years older than it was then. So that hasn't changed.

Nathan Jones, Stifel.

Good morning, everyone. And thanks for that great explanation to Andrew's question. That was very helpful. In your prepared remarks you talked about Europe being -- I think it was 11% up year to date. Is there any way to parse out what is OE versus aftermarket in that growth?

There is, but we would probably have to get back to you. I have a lot of numbers in my head but that's not one of them that I've got.

Okay. Fair enough. No worries. $80 million of delays -- is it possible for you to parse out kind of what the impact of your better on-time delivery on that has been, rather than just customers delaying shipment?

Yes. I mean, I can tell you -- look, going to last year and years prior where our past-due backlog this up in the high-single digits, low-double digits, one thing we knew was when that product was ready it was going to be taken. And we cleared a lot -- if you actually look at the year-over-year compare -- a lot of last year was in a sense kind of driven up from prior years because we had a lot of past-due backlog to get out the door. And this year it's certainly less of the case.

We always want to continue -- we want to have zero past-due backlog, frankly. But the fact is we've driven it down quite a bit with improved execution, and that just means is not on the critical path.

So what I'll tell you is as long as we continue to execute well and the other factors that I described to you don't come into play -- that is, for some reason they need to accelerate these projects for fear that costs are going to go up significantly like you saw in 2008. I can't imagine at this point in the investment cycle on these projects which would cause them to shut the project down because there's already -- they bought the land, all the piping there, the long leadtime vessels are there. I guess I could fathom something, but the fact is I think that's what's going to drive it over that period of time.

Joe Ritchie, Goldman Sachs.

The first question is on 4Q. I take a look at your implied revenue guidance. Keeping flat for the year implies that the sequential uptick is at about 20%, and if I look back at your prior three years it was pretty consistent -- 4Q versus 3Q at roughly 13% to 14% sequentially. So can you just talk a little bit about the confidence in that type of sequential growth uptick in 4Q?

Yes. And if you would allow me, let me give you the opportunity -- I think there has been some confusion. When we talked about our guidance relatively flat constant currency, basically what we are saying is we see revenues flat for the year when you look at our P&L. The remark around constant currency was if there's any significant moves and currencies from this point on, obviously that's going to impact it as you saw it did even in the month of September Q3. So let me make sure we clear that up.

Now, as we look going forward, we've seen some slippage. We've taken that into consideration in our guidance. We have more backlog than we did last year. If you think about it the backlog is up versus last year. The aftermarket backlog is up versus last year. So that's the underpinning for why we put out relatively flat for the year, which you can reverse engineer to what you have as a fourth-quarter revenue number.

Okay. And maybe asking, following up on that a little bit -- how much of what you already have in your backlog is going to burn through in 4Q? Do you have that number?

No, not offhand. I mean it's going to be project by project. Again, aftermarket tends to be shorter cycle. The brand rate business does as well. But I can tell you the way we run our business, we go site by site and how we forecast is we look at the projects when they are due, when we expect them to do, what we are hearing from the customer -- that can obviously change but that's certainly how we build of the forecast.

Brian Konigsberg, Vertical Research.

Actually just following up on Joe's question, so the implied flat full-year guidance and what it implies actually for the fourth quarter -- it seems like you are assuming that delays of $80 million would likely have been shipped in the fourth quarter, and there's probably no new delays that emerge. That actually would probably take the sequential cadence down to a more normalized level between Q3 and Q4. So is that the way we should be thinking that it's being planned or not?

I think I made in my comments, this could persist -- things slipping from one quarter to the other. But the point is what slipped into this last quarter may be in next quarter and what may slip going forward. Keep in mind, Q4 has consistently -- I can't think of a quarter certainly since I have been here -- is our biggest shipment quarter. There's a whole host of reasons for that. A lot of customers -- their budgets reset at the beginning of the year. They want to make sure they get things in especially in the emerging parts of the world.

It's just the way -- the cadence of our business is a lot of stuff is shipped in Q4. So when we look at our forecast, what we do is we build it up by the project. We look our -- more of our run rate business and our quick ship business, and that's how we forecast Q4. Things can impact that. Obviously if there's some big push to get all the equipment in, that could create an upward bias. If there is -- for some reason people even slowed down a little bit further, that could impact it is well. And obviously who knows what's going to happen with currency at that point in time.

Really our forecast in the fourth quarter is based on if you look sequentially over the last couple of years, it has been well over $100 million Q3 to Q4 increase in our revenue side. And then underlying that in the EPS is what component of that is run rate and aftermarket business versus some projects. Obviously, aftermarket has more contribution to the EPS line.

It does. And I guess just kind of my follow-on question really had to do around incrementals because to get to the midpoint of the EPS range for the year implying back now for Q4 is about $1.14 -- it suggests the incremental is quite high to get there and that is, I think, as you are saying, that is actually more mix than anything or are there other items that could help that?

Also it's fixed cost leverage. If you look at our leverage across G&A -- but, Brian, that's what we put the range out there is because if we could predict to a point in time -- that's just not the nature of our business. Again, in our world a project is years not days. That's typically what we have out there. We just take assumptions at a point in time. We have a currency in a point in time. We look at our backlog and the things that you mentioned as well. We've got a higher aftermarket backlog that we had at this time last year. We look at things like that to say.

There's a lot of things that can happen. Look at what happened with below-the-line currency this quarter -- that can flip next quarter. We can't predict that or forecast that. We don't even try.

Thank you. Ladies and gentlemen, we have reached the allotted time for the call. This concludes today's conference. Thank you for participating. You may now disconnect.