福斯 (FLS) 2015 Q2 法說會逐字稿

Welcome to the Flowserve 2015 second-quarter earnings 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 Investor Relations and Treasurer. Mr. Roueche, you may begin.

Thank you operator and good morning, everyone. We appreciate you joining us today to discuss Flowserve Corporation's financial results for the second quarter of 2015.

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 Karen Ovelmen, Executive 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. As a reminder, this event is being webcast and an audio replay will be available later today.

Before turning the call over to Mark, I will note that we filed our Form 10-Q, issued a press release and prepared an earnings presentation for our second-quarter 2015 results which are all available on our website at Flowserve.com in the investor relations section.

Additionally, please be aware our earnings material do and this call will include non-GAAP measures. Among the non-GAAP figures cited include our adjusted earnings per share metric. We have reconciled our adjusted EPS as well as our other adjusted metrics to our reported results prepared in accordance with Generally Accepted Accounting Principles which can be found in both our press release and earnings presentation.

Please also be aware that this call and our associated earnings materials contain forward-looking statements which are based upon forecasts, expectations and other information available to management as of July 30, 2015. These statements involve numerous risks and uncertainties including many that are beyond the Company's control. Except to the extent required by applicable law, Flowserve undertakes no obligation and disclaims any duty to update any of these forward-looking statements.

We encourage you to fully review our Safe Harbor disclosures contained in yesterday's second-quarter materials as well as our other filings with the Securities and Exchange Commission for additional detail. We encourage you to fully review our Safe Harbor disclosures contained in yesterday second-quarter materials as well as our other filings with the Securities and Exchange Commission for additional information.

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. Flowserve delivered solid operating results in the 2015 second quarter in light of the current business climate. As you know, the challenging markets we experienced earlier in the year extended into the second quarter with broad-based capital spending declines, a strong US dollar, low oil prices and heightened pricing pressure on new orders. Headwinds in many of our emerging markets also increased last quarter adding to the tough business environment.

Although there were some signs of reduced volatility in the quarter with oil prices and currency trading in a tight range, overall market uncertainty continued. Our outlook for the rest of 2015 has moderated with the assumption that current market conditions will persist. With this updated view in combination with our first-half results, we have adjusted our revenue and earnings guidance.

Despite these challenges, Flowserve is performing well operationally and is navigating the current business environment. Although customers remain deliberate and measured in their release of new orders and acceptance of finished goods, Flowserve's adjusted sequential bookings and sales increased by double digits reflecting our normal seasonal increase.

On a year-over-year basis, our bookings excluding SIHI were down roughly 15% on a constant currency basis. This was a tough compare period since as you may recall, our bookings a year ago included a few mid and larger sized projects including our largest award in 2014, which together made last year's second quarter our strongest booking period since 2008.

Our aftermarket franchise performed well despite continued maintenance deferrals in some of our markets and lower parts and spares activity tied to new project orders. Many refining and chemical customers delayed upgrade projects and maintenance to take advantage of current strong profit periods. Even with these deferrals, our aftermarket bookings declined only 5% on a constant currency basis demonstrating the resiliency of the MRO business.

While our adjusted gross and operating margins declined in the second quarter as compared to the prior year primarily as a result of lower levels of activity and the currency impact, our operating platform remained solid. The operating improvements we have implemented over the last few years in product quality, on-time delivery, customer responsiveness and manufacturing efficiency have taken hold which allows us to focus on Flowserve's next evolution, permanent reductions in our cost structure.

As we announced on last quarter's call, we have accelerated our strategic manufacturing optimization and cost efficiency plans. These type of changes take careful planning and execution to ensure customers are not impacted and to comply with local requirements but we are aggressively proceeding. These structural changes will provide us increased flexibility to compete in the current market environment. It will further improve the efficiency of our operating platform and enhance our competitive position for when conditions improve.

We are also meeting increased customer expectations through our ongoing efforts to improve our low-cost sourcing and increasing our emerging region capabilities which is where new capacity investment will be concentrated.

This greater geographic flexibility when combined with our attractive and diverse end market exposures, increases our ability to capture opportunity when it occurs. We have invested substantial capital in recent years increasing our capabilities in emerging markets including China, India and Brazil. These facilities have now built a track record of performance and are prepared to permanently take work from some of our higher cost facilities in developed geographies.

Turning now to our second-quarter activity by regional market excluding SIHI and currency, bookings were down in all regions with the exception of the Middle East and Africa. In North America, our largest end market, bookings held up reasonably well considering the macro environment and were down less than 1% while sales were up modestly. Many of the headwinds I discussed earlier apply to North America but with all of the infrastructure projects that are underway or in the planning stages, opportunities do remain in the region.

Europe was a story of two extremes this quarter. Bookings were down over 35% but sales were up over 20% as we worked through that region's backlog. In last year's second quarter, Europe had its largest booking quarter since 2008 so this year's decline was against a tough compare that included some of the mid and larger sized projects which we discussed a year ago.

Bookings in the Middle East and Africa region were up over 4% in the second quarter. Even as this region tends to be an oil and gas driven economy, the national oil companies operating there continue to demonstrate a somewhat consistent, long-term approach to investment.

Asia-Pacific was down double-digit percentages in both bookings and sales reflecting slower growth in some major countries and increased price competition from local market participants.

Latin America remains a very challenged region with political and financial headwinds in a few of the larger countries which means it could get worse in the near-term. As a result, bookings and sales were both down in the region this quarter. We remain encouraged by future opportunities in Mexico as a result of the anticipated foreign investment in the oil and gas sector and we believe that in the long term, this region will return to growth.

While we are responding to current market conditions, it is important to also keep a long-term view. When we look at the big picture, we expect that our served industries will return to growth in the long term.

In fact, end-user demand for electricity, refined products and chemicals is increasing while existing infrastructure continues to age. Therefore even as we take permanent actions to improve our cost structure and operating platform which will further our competitiveness, we remain very focused on growth and future opportunities within our markets.

Last quarter I mentioned some of our initiatives including expansion in targeted end markets such as Asia power and chemical as well as our strategies to better align our selling practices with our customers' buying preferences through key accounts, expanded distribution sales and product bundling. Together these efforts should enhance our opportunities in any market condition.

Driving greater value through our aftermarket platform remains a growth priority. As our products become increasingly complex and in-house maintenance crews near retirement, we leave the value proposition from our aftermarket services will only increase.

As in prior cycles, we continue to make disciplined investments to expand our local presence and target a greater capture of our global installed base. These investments include some new QRCs, but primarily encompass initiatives to increase capabilities within the existing footprint to leverage our full installed base and to increase synergies by combining facilities where it makes sense.

We are encouraged by the opportunities created from the SIHI acquisition and we will continue to evaluate other growth initiatives as well as pursue opportunities to optimize within our existing portfolio to drive long-term profitable growth and shareholder value.

Inorganic investments that meet our standards provide opportunities to leverage our global scale and improve the utilization of our manufacturing and QRC footprint. And private sellers appear to be slowly adjusting their valuation expectations.

All of our activities around our portfolio are evaluated using disciplined return requirements with a focus on shareholders including our commitment to an efficient capital allocation and structure.

Turning to our outlook for the remainder of the year, there are mixed signs. The second quarter stability in currency levels and oil prices was a positive start although volatility returned to the commodity in July. The continued high level of utilization of our customers' facilities combined with the recent deferrals support higher levels of maintenance and repair work in future periods. This type of activity cannot be delayed indefinitely but the timing is difficult to predict.

Additionally, the current level of asset utilization will also tend to support our run rate OE work as customers focus on the efficiency of their facilities and associated upgrades.

The challenges to our outlook are primarily fewer expected project opportunities in the near term with increased price competition and headwinds in emerging regions. We believe our experience in similar market conditions combined with the aggressive proactive measures we are taking will position Flowserve for success.

Although we have moderated our outlook for this year and have taken a cautious outlook regarding any near-term market recovery, I remain confident in our business model, our strategy and most importantly, our people. Taken together, we are focused on delivering value for both our customers and shareholders as we position Flowserve for the future.

Lastly, I would like to welcome Karen Ovelmen, our new CFO, to this forum. You will be hearing from her shortly but I will note that she has hit the ground running during her first two months and I look forward to Karen's leadership and contributions as we go forward to drive long-term shareholder value while navigating near-term market challenges.

But first, let me turn the call over to Tom.

Thanks, Mark, and good morning, everyone. As Mark highlighted, market conditions remain challenging. We were reasonably pleased in this type of environment that our book to bill this quarter was close to 1 excluding SIHI at 0.97. This helped ensure that our organic backlog remained intact and was even up modestly year-over-year on a constant currency basis which provide support to our revised 2015 outlook.

Longer-term, we continue to believe in the growth opportunities within our industry as the fundamental drivers for the infrastructure business has not fundamentally changed.

To respond to the current market however, and to position Flowserve for the future, we announced last quarter that we are accelerating our planned long-term manufacturing optimization strategies. These actions are permanent structural changes that will close capacity or reposition activity in many of our existing higher cost developed region facilities while leveraging our significant investments made and our enhanced capabilities in lower cost emerging markets.

As part of this initiative, we will also make greater use of third-party suppliers to reduce our fixed cost structure. Since that announcement, we have made notable progress towards our goals. This effort will not be a quick or easy transformation but we are moving forward with a sense of urgency.

We also implemented a cost efficiency initiative to reduce our headcount and expense structure to align with the current business environment. Together we are targeting roughly $100 million of investment which we expect will generate at least $70 million in annualized savings once we implement all of our actions in mid to later 2016.

In the second quarter, we recognized $24.7 million of realignment charges for these initiatives and expect to execute on most of the remaining actions by year end.

Despite these significant changes, our employees have remained focused during this busy period, continuing to deliver on our commitments to our customers. Our on-time delivery metrics, past-due backlog of 4%, and second-quarter's solid margin performance, together demonstrate the continued efforts and culture of execution.

Looking at the booking environment, the lower level of project opportunities we saw in the first half of 2015 has increased competitive pressure on the business that is available in the market. Customers are seeking greater value from their investment dollar. This conversation typically initiates as a pricing discussion and our initiatives to drive out costs will help respond to this request.

However, we are also demonstrating how Flowserve can support their goals with our unique value proposition beyond price alone. By leveraging our global reach and comprehensive flow control portfolio, we can deliver value to our customers through product bundling, certifying lower cost facilities and collaborating earlier in project design work. We believe this approach is consistent with our focus on leveraging the underlying strength of our platform in driving profitable growth.

From an aftermarket standpoint, we delivered constant currency bookings that were down only 5% excluding SIHI which showed signs of resiliency we generally expect. The first quarter labor strikes that affected many US refining and chemical customers have largely ended which is a positive development. However, in addition to managing their capital budgets tightly, the strong margins that some of these customers are currently producing resulted in continued deferrals of maintenance work to later periods so that they can capitalize on current period profitability.

Given the combination of these takedown deferrals, lower upgrade opportunities and fewer parts and spares tied to new units, we do expect continued headwinds in our aftermarket business for the remainder of the year.

The good news is this delayed work was not lost, it just represents a future opportunity. Even with the expected near-term challenges to our aftermarket business, we view this franchise as a solid resilient foundation. We continue to invest in and execute on our strategies to increase our aftermarket capture. Key to this effort is increasing our ability to support clients possessing our installed base as well as assisting in their broader reliability and maintenance opportunities.

At the same time further identifying pockets of installed base, increasing our localization efforts including new QRCs, enhancing the capabilities of some of our existing facilities and consolidating others where appropriate. Growing our aftermarket franchise remains a top priority and opportunity for Flowserve.

Looking at the end markets during the second quarter on a constant currency basis and excluding SIHI for a clean comparison we have, the oil and gas bookings declined roughly 24%. This industry is experiencing both highs and lows. Upstream customers are suffering from low oil prices. However, the mid and downstream assets remain highly utilized as the demand for the finished product remains strong.

Flowserve is predominantly a mid and downstream supplier but these customers' efforts to maximize current period profits and delay new work where possible certainly affected us.

Looking at a couple of oil and gas regions, Latin America remained challenge, as Mark mentioned. Latin America as a whole got worse as Petrobras works through their issues and resets budgets. And Venezuela's financial crisis constrains Petrobras's activity.

In Middle East and Africa, proposal activity has remained solid which supports the thesis that this region will take a longer-term view towards continued investment. With strong end user demand from the mid and downstream markets, we believe investment activity as well as maintenance and repair opportunity is building and we will remain on the horizon near-term as we do not forecast a meaningful pickup in the second half of 2015 beyond our normal seasonal patterns.

In the chemical market, second-quarter bookings decreased by almost 17% versus a strong compare in 2014. We continue to expect ethylene expansion in North America with derivative plants related to the new capacity expected to come online over the next few years as well as a number of new projects in various preconstruction stages.

Similar to our refining customers, chemical margins are also currently solid for our customers and while the economic support continued investment, timing is always difficult to forecast. Regionally Middle East and North American chemical expansion remains a solid opportunity ahead.

Early in 2015, we increased our chemical presence substantially with the acquisition of SIHI. The integration of SIHI is going well and we remain pleased with the opportunities created from this acquisition.

In the power market, our bookings increased 11.6% versus prior year's quarter. In the US, coal retirements and low-cost natural gas are a catalyst for combined cycle plants since expected electricity demand is increasing.

Asia continues to invest in fossil-based plants and our local capabilities in the region improves our competitiveness for this work. China's new nuclear plants were the first since 2011 creating an opportunity for incremental work.

Flowserve has provided nuclear products for reactors worldwide and our capabilities and end stamp certifications are differentiating factors in a market where safety is critical.

In addition to China, Russia and South Korea see continued development in nuclear power and Europe is discussing new capacity in some regions as well. If India approves limits to nuclear supplier liability, that region could also potentially be a meaningful catalyst for Flowserve's nuclear work.

Following their new safety standards, Japan is getting closer to restarting a portion of its nuclear capacity which has been idle since 2011.

Bookings in our general industry markets are down a combined 12.8% in the second quarter as increased agricultural bookings and flattish food to beverage awards were more than offset by declines in our other markets in this segment. For the distribution channel, destocking continued and these customers were slow to restock. Like deferred maintenance, these orders will return in the future but in the interim, our customers maintain a cautious approach. We have increased our focus on this channel with a new leader, additional resources and a fresh strategic direction.

Wrapping up my prepared comments, while near-term uncertainty continues to impact many of our customers in end markets, Flowserve will remain focused on what we can control including increased aftermarket capture, operational excellence, targeted growth initiatives, product development and realignment of our global manufacturing base.

We continue to believe in the long-term drivers of growth in our key energy markets and are confident that the actions we are taking will better position Flowserve when our customers resume their growth investments.

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

Thank you, Tom, and good morning, everyone.

I'm very pleased to join the call today, my first as Flowserve's CFO. From my time thus far with the Company, I am excited about the opportunities ahead and I believe we are well positioned to continue the progress the Company has made over recent years to further drive value for our customers and shareholders.

Following Mark and Tom's reviews, let me now focus on the financial highlights.

Following our challenging first quarter, we were pleased with some stability in the second quarter which enabled sequential constant currency increases in bookings and revenues of 11.3% and 15.6% respectively excluding SIHI. Q2 2015 sales of almost $1.2 billion increased 4.8% on a constant currency basis and included $77 million from SIHI. Excluding SIHI, sales were down 1.5% compared to last year on a constant currency basis.

Turning to margins, excluding the $14.3 million charges related to our strategic realignment initiatives and the impact of SIHI, adjusted gross margins were 34.5%, down approximately 60 basis points from a year ago.

Our focus on tight cost control was again demonstrated this quarter. Excluding the effects of the SIHI and realignment, SG&A dollars decreased year-over-year by over $30 million reflecting our alignment with shareholders and the ability to flex to current market conditions.

Turning to our adjusted operating margins, the year-over-year decline is largely volume related. Adjusted operating margins were approximately 40 basis points lower than a year ago though still solid at 15.5%.

Our second-quarter tax rate of approximately 29% is in line with our guidance of 30% to 31%. Second-quarter adjusted EPS of $0.80 includes $0.06 per share of negative currency translation and excludes $0.24 per share of adjusted items comprised of $0.13 of realignment, $0.10 of net SIHI dilution, and $0.01 of below the line currency impact. Reported EPS for the quarter was $0.56.

Turning to cash flows, operating cash flow improved about 52% compared to the 2014 second quarter. Free cash flow also improved despite an increased level of CapEx spending and represented approximately $0.60 per share. As I mentioned, our capital expenditures for the quarter were up versus prior year as we continued to invest organically to grow our business.

In total, we invested almost $30 million in capital expenditures during the period as we made disciplined investments in our business including increasing our aftermarket strategies and emerging market capabilities to support long-term growth.

Similar to prior periods of slower end market activity, we will continue to pursue organic growth initiatives within our business.

Returning capital to shareholders also remains a key priority for Flowserve and in the first half of the year, we returned over $185 million to shareholders through dividends and share repurchases. Approximately $325 million remained available under our current share repurchase plan authorization at quarter end and we remain committed to our financial policies with regards to returning capital to shareholders.

Primary working capital as a percentage of our trailing 12-month sales improved modestly to 26.5% versus 29.6% a year ago excluding SIHI.

With regards to 2015 outlook and EPS guidance, as the Company evaluated its prior guidance, we balanced the current market conditions against the second quarter's relative stability in currencies, the price of oil and in our challenging markets. We took into account our first-half results with an expectation for further delays in deferrals in the second half which resulted in Flowserve revising its 2015 full-year adjusted EPS guidance. We now expect 2015 adjusted EPS between $3.10 and $3.40 on revenues that are down between 10% and 15%.

Currency changes are a major year-over-year factor in our guidance and as we indicated previously, a roughly 10% FX headwind on revenues impacts EPS by around $0.40.

Consistent with our previous approach, our guidance excludes both SIHI's revenues and its expected $0.25 per share net dilution for the year. Our adjusted EPS range also excludes the expense of our $100 million realignment plan, below the line currency impacts, as well as other specific one-time events such as the first quarter's Venezuelan remeasurement.

Our guidance also suggests that 2015 will reflect our traditional seasonality with earnings more weighted to the second half of the year. SIHI has been performing in line with our expectations and is expected to follow a similar seasonal trend.

Finally, we still expect capital expenditures in the $170 million to $180 million range for 2015. At this level, we will continue to position our business to grow organically and profitably by improving our capabilities around the world.

Before turning the call back to Jay, I would like to mention that I'm very much looking forward to meeting with many of you over the coming months. Although in the near-term, Flowserve faces challenging markets, over the longer-term the fundamentals remain very strong. Our diversified end markets, comprehensive product portfolio and geographic exposures coupled with our growth initiatives and cost reductions positions us very well today and into the future.

I look forward to discussing with all of our stakeholders Flowserve's competitive positioning and our continued focus on creating meaningful shareholder value. Jay?

Thanks, Karen. Operator, we have concluded our prepared remarks and would now like to begin the question-and-answer period.

(Operator Instructions). Scott Graham, Jefferies.

Good morning and welcome, Karen. I really only have two questions for you. Tom, it sounds to me like you are pulling forward the benefits of the restructuring tag to be about $70 million. Is that a fair way to read your comments?

I would say if you look at the $100 million of cost and the $70 million of benefits, while we're trying to execute that as soon as possible, a lot of that is going to -- like we said in the mid to later part of 2016. We will however try to maximize that as much as possible but it is going to take a direction because some of these initiatives are pretty complicated.

Understood. Second question is really I think equally as simple and maybe more for you, Mark. The push outs of the deferrals affecting the aftermarket and your services and what have you, obviously those things do have to happen at some point. But you are saying I think you are saying implied in your guidance is that you are not expecting them in the second half of the year. Is there some type of catalyst, is there a trigger that you guys are watching here that says okay it is time is that oil at may be a little bit higher level to hurt those refining margins and to take them off line? Because obviously oil at a higher level helps you in one way, potentially down the line but certainly hurts you on a more near-term basis in the other way. Is it the price of oil, is it the price of ethylene? What are some of the triggers, Mark?

It is primarily going to be the spreads between what they can retail and what they can acquire the crude product and that is gapped out quite a bit if you have been to the pump recently, it hadn't fully reflected what you have seen occur at the price per barrel of oil. So that will tend to -- a refiner is kind of like a bond, they are going to generate as much cash as they can for as long as they can. But in no instance will they put the refinery in harm's way. So I'm not (technical difficulty) push it out and typically these are scheduled take downs, regular scheduled maintenance.

So they can push them out for a period of time. I think the best thing to do is they made some commentary I think some of the refiners were talking about turnarounds and expense in the beginning of next year. So they will typically talk about that because they communicate this as a positive. They said look, we are making a lot of money, we're going to run these things flat out for a period of time. But it depends on a customer by customer basis.

But typically these are scheduled takedowns so I am not suggesting they are putting these things in harm's way but they do need to -- eventually efficiency will start to get impacted and they do have increased risk if they run them for too long.

We saw this back in 2009 but if you remember, oil moved back up fairly quickly and that brought that deferred maintenance back in. Oil has been down for a fairly sustained period of time compared to six years ago.

That is exactly what I was alluding to. Thank you.

Kevin Maczka, BB&T Capital Markets.

Thanks, good morning. Mark, a question on the OEM side as we look out to the back half of the year and into 2016, and I know you are guiding 2016 yet. But I'm just wondering how concerned we should be about that because as I have understood it, Flowserve demand comes somewhat in the middle of in cases of a multiyear construction project. So things that have been underway maybe are continuing on but at some point we are going to start to burn backlog and maybe new projects just won't be there because we are reading about the additional $200 billion in oil and gas CapEx cuts coming.

So can you just talk about your view and how we should be thinking about the OEM side out into 2016?

As we typically talk about, let's talk about these large projects versus run rate because the large projects have been a smaller portion of our overall business. Here is probably the way to think about it. There will always be projects out there almost at any price of the underlying commodity because of aging infrastructure. There is a whole set of needs around energy independence, trying to capture more of the verticals which is what they are doing in the Middle East, a whole host of things that will drive investment. And a lot of that is some of the long-term drivers in our business.

Really there is going to be more demand as you look over the horizon so that is a general backdrop in terms of the way you think about global capacity.

The fact that the multinationals have been rationalizing CapEx now I think we are into the seventh quarter so on more shorter-term, what the industry needs to do is see for example in oil and gas a price of a barrel of oil that they can start making investment decisions around. And what I mean by that is certain investments will occur obviously at 100 and certain investments will occur at 50. And what they are looking for at this point in time is to see where it is going to settle out and start making those investment decisions as you look in terms of really new project opportunities.

So that is probably the way to think about it and there is typically a trade-off. As oil has gone down, as feedstock, as natural gas has become more readily available, it does bring other investment in other areas in the chemical industry and in the combined cycle power industry. So it isn't again one-size-fits-all.

But what they do need to see and this is why we talk about volatility, they do need to see certainly for a barrel of oil particularly on the upstream side, they are going to need to see some level of stability that they can start making investment decisions around, keeping in mind that even if you look at the US upstream production on the fracking which we are not involved in, technology has brought a lot of that cost to production down. So it is not like the industry stands still. A long answer to the question.

Now on the other OEM as we talked about more of our run rate business, that tends to be more stable. And as Tom mentioned in his comments, those are some of the areas particularly in the industrial segment where we think we have a lot of opportunity to grow our business through some of the initiatives that we are driving. And SIHI is a good example of that. Those are good products that are fairly stable in almost any market and we need to start leveraging those on our platforms and also some of the internal development opportunities. That segment for us really represents a good opportunity going forward.

Got it. That is helpful. If I can just ask a follow-up on price. I'm just wondering if you can compare and contrast what you saw in the last downturn to what you are seeing now or what you think you will see over the next few quarters because last downturn, price was an issue and we were for many quarters, shipping low price, low margin backlog. How do you compare and contrast this one?

Well, in short we are a completely different company than during the last downturn. But let me try to lay some things out for you. Headwinds we are facing relative to the last downturn is the pricing environment and the projects and there were more of them was significantly better in 2008. You can actually take a step back and say there is probably 300 to 400 basis points of margin that doesn't exist in this cycle that existed in the last cycle as we wound through that backlog because the pricing environment was so strong on these projects if you look at it.

The other thing that represents a headwind -- and we have overcome a lot of those two things -- is if you look at the currency. The dollar in effect relative to where we were in the last downturn is about 30% stronger which impacts our financials and we have more international business. So those two things I think relative to the last downturn are representing headwinds when you are looking at compares.

You saw though that we lived through that lower-cost backlog during the end of 2010 and 2011. What is different is simply put I talked about being a better company. One example is we have reduced our cost of core quality by well over 300 basis points. Those are permanent changes in our business. Our aftermarket backlog and capabilities are significantly better.

We have more run rate product, more run rate penetration in our business. We are less reliant on these big projects. We also if you look forward relative to last period, we have more opportunity to make some structural cost changes in our business. Keep in mind when we came out of the last cycle we didn't have significant amount of low-cost manufacturing capacity in these markets. These things are up and running and qualified and represent now an opportunity to migrate long-term some of the capabilities over to these facilities.

So that is a high level compare. Honestly, this is a very long discussion in terms of what is different but we are much better positioned.

Got it, that is helpful. Thank you.

Deane Dray, RBC Capital Markets.

Thank you. Good morning, everyone. I was hoping to get some more color on two of the initiatives that you called out that sound particularly interesting. The first is on product bundling. You all are in a unique position within the flow sector of having important positions both in pumps and valves and seals. But what we haven't seen a lot in the way of bundling initiatives in the market so what might be new there? And then I've got a follow-up question regarding the capabilities to the QRCs.

One example to allude to without naming specifics is a lot of the multinationals have started seven quarters at thinking about their cost structure and in doing so have turned to suppliers and said help us drive efficiency through the entire supply chain. And one of the ways that we can do that is to bring all of our product opportunities to the customer, work with them ahead of time, design specs, enter into frame agreements which we have done and in doing that bring our full capability to their capacity needs going forward.

So in doing that, what that does is that gives us scale in terms of the relationship, scale in terms of our supply base. It also gives them a benefit as well because they know the products that they are going to get, what the expectations are in terms of quality and delivery. That is one example that you can do it.

Another one is more traditional is if you look at project opportunities or whatever may be, typically you had some of our engineered product but we would also bring some of our industrial product for balance in plant. That has typically occurred as well.

And on the QRC, what types of capabilities are you looking to add and are there QRCs today that have the enhanced capabilities you are trying to model after or is this new territory?

I have made this point before, part of it is your aftermarket capabilities, the QRCs being just one of them. And we are fairly well-developed in the Gulf Coast region. What I mean by that is we have QRCs that can support pumps, valves and seals in the QRC itself, some that support one or more of those products. We have field techs, service techs, a lot of boots on the ground there.

The opportunities we look for other concentrations of processing capacity around the world is to create the same thing in regions in Brazil certainly in Malaysia, in China as well. So the QRC, the significance of that is it does provide the ability to respond very quickly relative to the piece of equipment and that is going to correlate to size. As you can imagine, one of these large pumps we are not going to have QRCs deployed around the world to handle those because you need cranage and it is going to take time to move it anyway.

But some of the smaller pieces of equipment you can pull and move fairly quickly to some of these facilities. So we look at the QRCs relative to what the needs are. Some of them are just seal QRCs and they are right close to the customer.

Thank you. Just last question for me would be for Karen and I was hoping you could share some of your initial thoughts on where you are focusing for starters and then maybe address some opportunities in working capital and cash conversion.

Sure. So I have been here two months. This is a very successful company that is running extremely well. There is an existing leadership team that is seasoned, in-depth industry expertise and has weathered these cycles before and then of course Mark has brought in a lot of new talent in a lot of different areas. So it is a company that I think is very, very well positioned.

My focus will be on adding to all the capabilities that are here, looking at the efficiencies, cost reductions, where can we push that in other areas as well as on the growth side of the equation in terms of what markets we want to look at, both organically and inorganically. So that is where my focus will be.

I have worked in many of Flowserve's end markets from oil refining, chemicals, plastics, this is a very customer focused company, on-time delivery, quality, performance culture. So the Company is doing very well in that regard and my hope is to continue that and add to that.

In terms of working capital, I do believe that remains an opportunity for the Company. There is a lot of effort and time and some success in those areas. Clearly the quarter showed some good progress on adjusted working capital as a percentage of sales. However, with only two months I do need to dig deeper and fully understand the puts and takes related to DSOs and turns and personally conclude where our targets should be going forward and where we can look at that from both receivables, inventories and a payable perspective. So that will be an area that we continue to focus on and I will be looking at that in-depth.

Robert Barry, Susquehanna.

Good morning. I was wondering if you could give a little bit more color on how broadly the pricing pressure is impacting the business? Is it focused on oil and gas or elsewhere and is it impacting the aftermarket?

Not an impact on the aftermarket. Those tend to be smaller activities, fairly stable in terms of the margin profile. Where you see the most competition is going to be in the oil and gas on some of the larger projects and as expected in the Middle East. We saw this before and it is typical in our industry that oil and gas in the Middle East is very, very competitive.

Got you, okay. So it is mostly oil and gas, not in some of the other end markets? Got you. Could you comment on the performance of the OE book and turn business in the quarter?

You mean the shorter-term time to OE? It was a little less than expected so that was part of the reason that we trended that out during the remainder of the year. We saw quite a bit of a pause for lack of a better term in the first quarter and saw some of that abate during the second quarter. But still I think people are looking at their budgets in terms of some of the smaller upgrade projects.

So we had certainly our share but it was less than we expected going into the year. Coming out of the first quarter, we just needed to start seeing some stability there. But clearly what I can tell you is where we did see stability was in kind of our base aftermarket business, the traditional repair work. What we have not seen come back in the aftermarket and even some of the OE upgrades are going to be those upgrades and certainly what we call spares tied to new projects because there isn't a lot of new project activity. So those have been in a sense kind of the puts or takes.

Where we also see an opportunity and I mentioned this earlier, remember our focus in our industrial segment really for four years has been getting the operating performance to where we need it to be. It is there. Now what we need to do is grow that business. So a lot of our initiatives around distribution, around e-commerce, around how we organize our sales force, really products that we offer and bring into the portfolio like SIHI, are driven around that industrial product segment. We think that really represents a good opportunity for us because if you think across our portfolio, the engineered businesses in general the big OE projects are very, very subject to market conditions. But the industrial products you really can, with our broad product portfolio, penetrate many markets in many type of environments.

I would just add to that, while the market wasn't substantially changed toward the back end of Q1 going into Q2, we were able to both on the OE side and on the aftermarket side sequentially increase those bookings and even though some of that may be seasonal, it still was at least a good sign that we did have an increase from Q1 to Q2 in both of those areas.

Got you. Thank you.

Joe Ritchie, Goldman Sachs.

Thank you and good morning, everyone. So, Mark, I wanted to touch on those comments that you gave earlier fully recognizing you guys are a different company this cycle then last cycle. But on the OE side of things, things were pretty good last cycle and pricing was good as well. Just curious on just your OE bookings, what kind of magnitude are you looking at in terms of potential pricing declines in that business today?

Relative to be last period when we came through the last cycle, is that your question?

I think more generally, just when I think about the cycle versus last cycle it seems like capacity isn't as tight leading to this downturn. And so I'm just curious on the pricing concessions that you are having to give on the OE side, I am just curious how those conversations are going and what kind of magnitude are we looking at?

It has definitely become more competitive but I can tell you the pricing change is not nearly as drastic as it was during the last cycle. So we have never really said it has been a strong pricing environment over the last couple of years. So the peak to trough, we are not through necessarily the cycle so I don't want to call a trough but the movement in the pricing is not nearly as dramatic.

And I've talked about this before but in the last cycle keep in mind on some of these big projects, we will buy up to 50% from other suppliers. We really can't command much margin in most environments. Back then you could get 20%, 25% margin on those and 40%, 50% margins on the equipment that you manufactured. It was a really, really good environment.

So as you look this versus last, the backlog in the last year what is very good executable, it doesn't have the price and we are starting to realize that. That is why we are pleased with our margins that we have seen over the first part of this year. It certainly doesn't have the margin in the big project that we saw last time but the movement in price from peak to trough is not even close to what it was last time.

So that is helpful. You brought up the margin point, good execution on the quarter and it is nice to see the restructuring actions are coming through. I'm just trying to understand just a little bit more clarity on the payback on that restructuring. I know that you talked about $70 million in benefits but it is unclear to me at this point how much of the $70 million do you expect to come through this year as opposed to the actions really kind of benefiting you in 2016?

If you look at the way that we have even started to accrue, we had 25. These are structural changes in mature markets particularly in Europe that take time to execute. Setting up the accrual is one thing, realizing the benefit does take time. And a lot of companies avoid doing this because it takes so much time in terms of the payback. We think this is a great time to do it.

So really very little of the benefits we expect to come through this year. We will try to pull as many as we can forward. But I think this is an important point. This is real structural strategic change in our business. We do have some component of it that is responsive to the market but most of this is permanent and we are continuing to look for opportunities. We want these things to be sustainable and if you think about it moving work, moving capabilities to low cost is really the way to play for the future.

But I would expect very little of these benefits to come through in this year. We will try to drive them as much as we can but most of it is going to be next year. These things take time.

Okay literally in that guidance number that you gave for this year?

Yes.

Okay, great. Thanks, guys.

Nathan Jones, Stifel.

So, Mark, just following up on some of the comments, you talked about 300 to 400 basis points of margin higher in 2008 that you are starting from now in terms of price, less reliant on large projects where the pricing pressure is the most intense. You've got more structural opportunities to take costs out. It sounds like -- and correct me if I am wrong -- that it is a reasonable expectation for investors to think that you are not going to see the same margin compression in this cycle that you did in the last cycle. Is that reasonable?

You are leading the right into margin guidance which we don't give. But I think what I was trying to do is illustrate that there are things you can compare to the last cycle and it is important to do but underlying this is a fundamentally different company. So what I don't want folks to do is just try to take the math from last period and roll it forward. There are too many things that are different as you look overall on our business.

A lot of that margin profile as we look forward are going to be the things we talked about, Nathan. Obviously top line from a currency impact standpoint and just an activity standpoint even on projects is going to have a decremental impact on margins.

To the flip side is cost optimization over a period of time is going to drive all other things being equal, margin improvement. Also as we start to scale the acquisition that we made, that should drive that as well.

So mix in terms of aftermarket so it is better as opposed to just trying to do the linear math from the last period of time to just step back and say on a relative basis what are they doing to drive margins and what are the headwinds? I think I've tried to line those out for you. But the timing of that and the duration of those things, they are going to impact margin and that is why we don't want to necessarily start guiding into margins but it is a better company.

Okay. I also understand that a lot of the structural realignment that you are doing is in Europe which takes more time. Is there any way you can give us any idea of what of the $70 million you expect to recognize next year and what of it will be incremental in 2017?

I think by the time we get to the back half of next year, we should be pretty close on a run rate to those savings, Nathan. So what I don't want to do is give you a full year number calendar January 1 to December 31 because the timing of that can impact the amount. It is really when we are going to start seeing the run rate on it, it will be in the back half of next year.

Okay, that is helpful. On the inorganic side, you talk there about private sellers starting to adjust some of their expectations. It sounds like maybe there is a few more opportunities out there that meet your criteria and I know previously you have talked about not being interested in large multiyear integrations and you seem to be more willing to do those now. How many kind of SIHI sized deals will you be willing to be integrating at one time?

That is a good question. We would like a lot of the SIHI type of opportunities and then we will find a way to integrate them to be honest with you but the fact is they come when they come. I think as we look at our priorities, the platform is much better and as the opportunity comes you can of evaluate it against what your options are. You can do an integration light. If it represents a really good opportunity, you can maybe time the integration over a longer period of time and just make sure your returns from a shareholder perspective justify that.

So there are things we can look at but I think we're going to look at each of these opportunistically in terms of returns to the shareholder and position this long term. And again going back to earlier things like SIHI are very valuable to us because they are in an area where we think we have some of the greatest opportunity, our industrial segment. These tend to be less volatile in market upturns and down. It leverages our sales platform, sales organization, our aftermarket capabilities as well and ultimately we can also start to leverage some of our low-cost manufacturing capacity.

So we hope to see a lot of these. The fact is, Nathan, when you look at these opportunities you have to take a step back and say what are my competing priorities in terms of integration, what is the pricing environment out there, what does this opportunity represent to us long-term and then you just make trade-offs. Obviously if a compelling asset came that we could get at a good price we may defer integration for a period of time and just take it on our platform.

William Bremer, Maxim Group.

Good morning, Mark, Tom, and welcome, Karen. Karen, look forward to seeing your initiatives on the DSO, that is first and foremost, I would like to start seeing that come through.

I guess my first question is really based on SIHI and we touched upon it, it is on track. Can you give us a sense of what type of restructuring possibly is needed there?

And then secondly, with the QRCs I believe pretty much added about 15, we are up to about 190 but yet the Q sort of articulated that an earlier some possible combining based upon certain regions, just wanted you to get a little more granular on those if you can.

An example around combining them is if you look in the North Sea region, we had a couple of QRCs that were supporting the North Sea activity and some of these facilities we have been in a long period of time and actually we acquired them and they were designed for a completely different use. I think one of them actually used to manufacture telescopes.

So what we did is we took a couple of these and built more of a state-of-the-art facility right there on the coast in Aberdeen to support it. So those are the things that we are thinking about where we can take some of these facilities, combine them, also combine them for pump, valve and seal capabilities to respond to the customers. The idea is and I was trying to tell folks don't think of these as retail locations like a fast food location that the more you add the more you grow. These things are going to be designed to whatever our customers need in the business.

Great, good point. That is all I have got.

Brian Konigsberg, Vertical.

Hi, good afternoon. Most of my questions have been asked, maybe just one more on SIHI. So you are saying the integration is going as you expected. Can you just talk about the topline performance, is that in line with how you anticipated it would grow or generate this year? What is the outlook?

Coming into the year it is as expected. When we looked at this asset over the last year, the markets were different. It hasn't moved too much from the original expectations but certainly as we gave guidance this year it is pretty much in line with expectations. As a matter of fact I think in the first quarter we were a little ahead and this quarter we were a little behind.

Got it. And just secondly, just with the receivables, so you have been talking in the Qs about just having trouble collecting down in Latin America, it has been a while now. At what point do you have to consider start taking reserves against that?

We always evaluate that. We have seen some progress in the region in this quarter, in the third quarter. But that is something we always evaluate in communication with our customers and the like. But that is something front of mind and we always of evaluate in terms of when we look at it.

I will leave it there. Thanks.

David Rose, Wedbush Securities.

Good morning, thank you for taking my call. First, nice job on executing in the quarter. I think most of us were pretty pleased given the environment. I had two questions if you may. On the outlook for next year, I know you don't want to go into it but I think as we start to look into next year and given where the bookings are in nominal terms, you got a pretty big step down. So what do you need to do in terms of cost takeout or conversely at least on the top line in order for you to get to operating numbers that are essentially flat year-over-year? You have got a lot to make up for so help us kind of think about things that would help you.

Well, we have talked about the unknowns and the unknowns are going to be the large project activity, what happens with the underlying commodities and certainly currency going into that period of time. We can't control those but let's spend a little time on what we can control. What we have talked about are some of our structural restructuring activities and we can continue to look at some of those as well to drive value.

These things will take time. We actually have a multiyear plan we have started to accelerate it, we can accelerate more. I think the other things that we talked about are looking within our portfolio or our capabilities and what can we do to improve topline capabilities?

I have alluded to one a number of times on the call around our industrial products segment. It is not only integrating the acquisition that we have made but there is other opportunities in terms of how we optimize our channels to market and taking advantage of that, obviously growing our aftermarket business, something we talked about last time.

So what we are going to do -- R&D, product development, these are all things that we are turning increased focus to not that it wasn't important before, just keep in mind our priority over the last three years has been around improving execution and you have seen that in our results in terms of the margins.

Looking forward, more of our time and effort and investment is going to be in relative market share capturing that as well. So the big thing around next year is just the unknown is what is going to happen to our industry during the back half of the year.

Do you think all else being equal if you can maintain the bookings where they are today -- and again I don't want to get into guidance -- I do but I know you won't go there. But you've got a $400 million deficit in bookings. Do think you can pull it off? Do you have enough levers at your disposal? You've SG&A -- the restructuring is really back end waited for next year so --?

You are going into calendar year versus beyond. As I said, I think we have -- we have already started to execute and we have substantial opportunity on the structural changes. So there is quite a bit there for us. And there are other levers we can pull but again we still do depend on project activity in our business. It has been less of our business over the last couple of years and it is just tough to call.

But the things within our control we can certainly add value and I don't want to give guidance in the next year but what I don't want to say is look, if you take a step back and if we were operating completely efficiently as we could which we are not and we were fully penetrated in our markets, we wouldn't have any levers to pull and all I would be saying to you is we are subject to whatever the market tells us we can do.

The fact is we probably have as much or more on things that we can do versus what the market can do to us. The question is we need to get after them and we are and those things take time. And a lot of that as Karen alluded to is some of the leadership that we brought on to help us drive through that.

So it is timing dependent but long-term the way we look at our business is we do think there is going to be demand in our industries long-term. I view what is occurring in oil and gas right now as more on the supply side. You've got Iran with 40 million barrels sitting in storage ready to go to the market, the increased production there, Iraq is coming up to speed.

There are a lot of things that are occurring but you also have depletion rates increasing in parts of the United States to offset some of that. So that will work itself out over a period of time. Investment will find the right opportunity and the right price to bring it back online.

Also keep in mind whereas we were having this discussion a year ago and everybody is saying why aren't you more upstream, the fact is midstream and downstream does not go away in tough markets. They may rationalize some of the new project activities but it is still operating and there is still need for this type of infrastructure.

So I just ask take a step back, let's take a long-term view because some of the things we are doing to fundamentally change our manufacturing capabilities around the world will take time but they have very good paybacks to them.

Joe Giordano, Cowen.

Hi, everyone. Thanks for running a little bit long to fit everyone in here, appreciate it. Just had a question on -- in the downturn here is there an opportunity maybe to look at the entire portfolio of products and streamline some of the lower margin, lower margin products to lever up on a recovery here?

In an upturn and in a downturn, we should be doing that. You have seen some of the actions we have taken over the last couple of years and we do. As we take a step back we look at our products and really primarily look for strategic fit. And we scale them across our sales organization is our aftermarket capabilities and if they don't make the fit, then we assume as you have seen with some of the divestitures that we made, that they are more valuable in other people's hands and so we want to monetize that.

Flip side on the M&A and we haven't talked a lot about that but one of the things versus where we were four years ago is we do have a better platform to integrate M&A. So we are going to look both primarily on the acquisition side but we always look on the divestiture side to say is there something we ought to stop doing or sell to somebody else?

And then just lastly, I wanted to touch on valves quickly and all things considered that was a very impressive performance in that segment. And based on what we are seeing in other people reporting, it looks like potentially gaining some share so can you talk about how you are executing there and what specifically if anything you can call out there?

They have been executing at a high level for quite a period of time and I think one of the advantages they have relative to our internal portfolio is that well-developed channel to market both in terms of distribution and some of the other channels as well. So they are further along and that is why I talk about the opportunity in the industrial segment because there is a tremendous amount of similarity.

But I think what you have seen is a whole host of things. We talk about lead product, secondary product and if you remember that strategy is to have competent capabilities oftentimes in some of our mature markets but start to lever some of the work in low-cost manufacturing parts around the world. They probably had one of the more successful examples of that. It is five years into it so these things do take time.

It drives great margin in their control valve business. So there is a good play book there that we are using for our other businesses, particularly we are going to start using it on the industrial product side. And that is the example that you have seen and you have seen good growth in the oil and gas business. Five years ago it was predominantly chemical. We made a strategic move through Valbart into the oil and gas products. They have been able to scale that and lever that into the other products that they manufacture.

And then one question that came earlier, this concept around bringing on our full portfolio to customers, they have certainly benefited from some of the rotating equipment relationships that we have had.

Great. Thanks so much for the color.

We are showing no further questions. Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.