福斯 (FLS) 2015 Q3 法說會逐字稿

Welcome to the Flowserve 2015 third-quarter earnings 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 Jay Roueche, Vice President, Investor Relations and Treasurer. You may begin.

Thank you, Operator, and good morning, everyone. We appreciate you participating in Flowserve's 2015 third-quarter earnings call. 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 Karyn Ovelmen, Executive Vice President and Chief Financial Officer. Following our prepared comments, we will open this call up to your questions. As a reminder, this event is being webcast and an audio replay will be available.

Additionally, please be aware our earnings materials do, and this call will, include certain non-GAAP measures. Please review the reconciliation of our adjusted metrics to our reported results prepared in accordance with generally accepted accounting principles, which can be found both in our press release and our earnings presentation. Please also note 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 October 30, 2015. 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 these forward-looking statements.

We encourage you to fully review our Safe Harbor disclosures contained in yesterday's third-quarter materials as well as our filings with the Securities and Exchange Commission, which are all available 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. During the third quarter, Flowserve delivered solid operating performance. This came in the midst of the persistent macroeconomic and industry-wide challenges we have faced all year. The continued weakness in many of our end markets has substantially impacted the timing of customer spending across the industry. As a result, there is increased uncertainty in the marketplace and a tighter pricing environment on the projects that do proceed. Further, most emerging regions, particularly Latin America, remain stagnant and with our global revenue base, the stronger US dollar continues to weigh on reported earnings.

Given this uncertainty, we are taking aggressive action to reduce our cost structure and offset near-term market weakness. More broadly, this current market downturn also provides us the opportunity to accelerate efforts to drive permanent efficiency improvements across our business to better position Flowserve for the long-term. Against this backdrop, Flowserve continues to perform well operationally. Our employees remain focused on serving our customers with excellence. This dedication is evidenced by solid execution on our existing backlog and our ability to deliver on our commitments the way our customers expect.

While opportunity always remains to improve on-time delivery, I am pleased with our consistent 90%-plus on-time delivery performance, our approximate 5% in past-due backlog and our operational performance. Simply put, Flowserve operating platform continuous to operate at a high level. For example, our after-market franchise demonstrated the relative resiliency that we expect. Despite continued maintenance deferrals in some of our markets and lower parts and spares activity tied to new units, organic after-market bookings and sales were only down modestly, constant currency. We expect much of our customers' delayed and deferred activity to return as maintenance budgets stabilize. As we have demonstrated over the years, we will continue to enhance our after-market capabilities through the cycle to increase our installed base capture and market share.

Given the cyclical nature of our markets, we remain focused on controlling what we can. Disciplined cost control is embedded in our culture, as is our strategic approach to optimize our business and to simplify the organization. We have made significant progress on our previously announced cost efficiency efforts and we are pleased that the expected return from our previously announced $100 million realignment investment has increased. We are also pursuing at least $25 million of additional investment to further improve our platform. Together, we now expect these actions to generate approximately $125 million of annual structural cost savings for the one-time cost of approximately $125 million.

Karyn will cover more on the timing of our restructuring actions as well as our third-quarter financial results, but I will note that I was pleased with the resilient margin performance this quarter, even in a declining revenue environment. When we look back at the second quarter, crude oil had seemingly found a home during that period in the $55 to $60 per barrel range. As you are aware, however, after July 4 and continuing through much of the quarter, crude prices suffered another round of declines, even falling below $40 per barrel in late August. This volatility increased uncertainty further within our industry. In turn, this impacted both the timing of bookings and customer willingness to accept shipments. This climate is reflected when reviewing our regional markets.

Looking at our geographies, excluding SIHI and on a constant currency basis for consistency, bookings were down in all regions with the exception of Asia-Pacific, which was up modestly. North America represented the largest bookings decline in dollar terms versus a tough 2014 compare period. Last year, oil and gas activity was strong in our mid- and downstream markets and chemical orders were enhanced by the new cracker facilities in the region. In this region's current market, we see increased opportunities in the power industry and are beginning to work on a number of chemical feed projects.

For the second consecutive quarter, European bookings declined approximately 18.5% this period, while the region's revenue increased, representing the only geography that grew year-over-year sales this quarter. Russia continues to struggle with the current oil price levels and the general European recovery has proven slow and the economy remains fragile. Asia-Pacific went the other direction, as it increased bookings year-over-year but also saw the largest revenue decline on a percentage basis this quarter. The slowing economy in China is certainly having an impact on the region, although power opportunities remain. Our opportunity in the region remains increasing our presence and building our installed base.

Latin American bookings were by far the most impacted on a percentage basis, down nearly 30% year-over-year. This resulted from challenges faced by certain customers in the oil-driven economies of Brazil and Venezuela. We expect the petrol economies remained challenge while oil prices are this depressed. We do see pockets of opportunity in some countries in the region, such as Mexico and Argentina. While bookings during in the quarter were down in the Middle East, we do see near-term prospects in the region, as many of our clients here are investing through the cycle, particularly in Kingdom, Qatar and Kuwait.

Some of the opportunities on the horizon include refining projects as well as power and desal plants. While the current business environment remains uncertain and near-term visibility is limited, we do continue to believe that the long-term secular growth trends in all of our end markets remained very much intact, based on end-user demand. Infrastructure in developed regions require service and replacement activities and emerging markets need to build more. The Flowserve platform is operating well and we have opportunities to enhance it. Current delays and deferrals will create a recovery cycle in the future.

We are positioning the Company now for long-term growth and we have the experience in navigating difficult markets. And as evidenced by our current initiatives, cost control is embedded in our culture. This culture is coupled with our highly disciplined approach to capital allocation. Flowserve has been a consistent cash generator, even in periods of cyclical slowdowns. We are committed to maintaining flexibility through the cycle, which enables us to pursue organic and acquisitive growth, pursued realignment and restructuring initiatives and return capital to shareholders through dividends and share repurchases.

I am confident that the internal actions we implemented since the last down cycle, combined with our current efforts and our proven operational performance, will position Flowserve well for both the current market and for when markets recover. Flowserve is a leader in our industry and our commitment remains to deliver long-term value for our customers and shareholders. Let me now turn the call over to Tom.

Thanks, Mark, and good morning, everyone. I am also pleased that we are expecting to generate a stronger return than our original investment dollars than originally expected on our cost efficiency measures. As part of this effort, we are driving towards reducing our manufacturing cost space and achieving higher absorption within our facilities. Our overall plan should position Flowserve to better serve our customers and will include product transfers, facility closures and certain headcount reductions.

In addition, the integration of SIHI is also progressing well, including facility rationalization and transfer of some of Flowserve's activities into SIHI sites. SIHI's bookings for the year have held up well as the run rate nature of much of its business help ensure only a mid-single-digit year-over-year decline in constant currency bookings. While executing on SIHI integration and the strategic realignment actions across Flowserve, our employees have remain motivated and focused on the customer.

Turning to our end markets, there are many challenges currently across our diverse graphical and industry exposures, but opportunities exist as well, as evidenced by our $1.06 billion of bookings, including SIHI. To break it down, oil and gas represents roughly 34% with chemical at 25%, power at 14% and general industries at roughly 23%. We have seen significant year-over-year declines in our project bookings as we continue to expect customers will remain deliberate in lengthening the bidding process and the time span before reaching the final investment decision.

Additionally, project pricing levels have intensified. While we have remained disciplined, we expect part of our planned cost savings with help reduce the effect of lower market activity and the impact on margin. We also continued to actively pursue enterprise frame agreements, product bundling opportunities and value-creating initiatives such as reliability models with our customers in order to drive bookings.

Looking at our served industries, in the oil and gas, the market remains challenged. European and Latin America oil and gas markets face headwinds that are not expected to cease in the near term. We also see maintenance deferrals occurring as refiners continue to operate high-level. However, some opportunities exist in this challenged market. There are pockets of oil and gas proposal activity, such as the Middle East and selective Asian reasons and refiners in Malaysia and refining in Saudi Arabia. North America LNG plants, midstream oil and gas and oil storage, however, represent opportunities. In Mexico the (inaudible) of the oil industry should also be positive in the future. The ongoing activity for LNG exports out of the US is another example of a new developing market where we participate.

Chemical bookings were roughly flat in the third quarter on an organic constant currency basis. We continued to see opportunities on the horizon from derivative typical facilities related to the first wave of ethylene crackers in America. Additionally, we also expect to see a second wave of ethylene crackers in the future, based upon recent E&C awards with the process potentially starting sometime next year. Power bookings were up 2% in the third quarter on an organic constant currency basis where we see combined cycle power activity moving forward, particularly in North America, Asia Pacific and Eastern Europe. With increased environmental regulation and the related closure of coal-powered facilities, this trend toward combined cycles should continue to drive opportunity for us and we also expect increased activity related to environmental driven upgrades on the coal capacity that remains.

Flowserve is also active in most nuclear markets. China continues to prefer ambitious nuclear capacity goals are we regularly participate. Japan has restarted some of its idle nuclear plants, which provides us opportunity for maintenance and upgrade activity. Finally, desalination markets have improved recently and concentrated solar power projects are emerging in Africa and North America.

We have escalated our focus on new product development over the last several months in the areas such as materials and coatings, multi-phase flow, fugitive emission and growing areas of diagnostics and its impact on reliability. These initiatives have resulted in new wireless control valves, water pumps with improved efficiency, designed to reduce the total cost of ownership and cryogenic valve applications, to name a few. In summary, although we expect a tough market for the near term, we have built a solid base, a rigorous plan and the ability to pursue opportunities where they exist. With that overview, let me now turn it over to Karyn.

Thank you, Tom, and good morning everyone. Let me now focus the call on our financial highlights from the 2015 third quarter and our near-term outlook. As Mark and Tom indicated, the challenging market conditions from the first half of the year continued in the third quarter. Accordingly, or in the third quarter our constant currency bookings declined 14.6% year over year, excluding SIHI's contribution of $70 million. Original equipment orders were primarily affected considering our $460 million organic after-market bookings were down only 2%, constant currency, which demonstrates the type of resiliency we'd typically expect from this franchise, especially considering some of the ongoing delays in maintenance activity.

Total third-quarter sales were $1.1 billion, which included $74 million from SIHI. Excluding SIHI, sales were down 5.6 % constant currency compared to last year. Again, our after-market business held up better as sales declined only 2.3% on an organic constant currency basis in the third quarter. Year to date, Flowserve's constant currency revenues increased 2.8% through September 30 compared to 2014 levels. Looking at our margins, strong execution after-market mix and cost control delivered adjusted gross and operating margin increases of 110 and 50 basis points, respectively, compared to the 2014 third-quarter.

We continue to focus on effectively managing SG&A, with expenses down $27.9 million in the third coring, excluding SIHI and realignment. As we position our business for current market conditions, our SG&A reduction reflected tight cost control and benefited from a strong dollar and reduced incentive compensation to reflect our alignment with shareholders. Our third-quarter adjusted tax rate of approximate 28.8% was slightly lower than our full-year guidance rate of 30% to 31%. On a reported basis, tax appears elevated at 35.5% as a result of one-off, non-cash value allowance we took on certain deferred tax assets reflecting ongoing challenges in Latin America.

Third-quarter adjusted EPS of $0.81 includes $0.06 per share negative currency translation and $0.03 of bad debt write off, due primarily to a customer's bankruptcy and excludes $0.11 per share of adjusted items comprised of $0.02 of below the line currency impact, $0.01 of realignment expenses, and $0.08 for the non-cash valuation allowance on the Latin American differed tax asset. SIHI was essentially breakeven during the 2015 third quarter even after incurring over $6 million of purchase price accounting, realignment and acquisition related expenses. Altogether, reported EPS was $0.70 for the quarter.

Turning to cash flows, Flowserve generated total operating cash flow of $113 million in the 2015 third-quarter, or approximately $0.85 per share. We continued to invest in organic growth, with $25 million in capital expenditures during the period. Similar to prior cycles with its slower end market activity, we will continue to make disciplined investments in our business to support long-term growth. We still expect capital expenditures in the $170 million to $180 million range for 2015, substantially higher than our maintenance CapEx requirements, primarily due to planned investment on the new Chinese valve facility, which will increase our low-cost manufacturing capabilities, as well as the purchase of a long-term license which will provide good opportunities to increase our after-market business.

Returning capital shareholders was another key priority during the quarter as we repurchased approximately 2.4 million Flowserve shares, which is almost equivalent to the number of shares we purchased in the first half of the year. During the first nine months of 2015, we returned nearly $320 million to shareholders through dividends and share repurchases. Approximately $215 million remains available under our current share repurchase plan authorization at third-quarter end.

Primary working capital as a percentage of our trailing 12-month sales improved slightly year over year to 27.1% versus 29.1% a year ago, excluding SIHI's impact. As result of declining sales as well as high levels of receivables from certain Latin American customers, our days sales outstanding increased year over year by two days to 286 days. Inventory turns were 2.5 times versus 2.8 times last year. Flowserve's balance sheet is well-positioned for the current market environment. Our trailing 12-month net debt to EBITDA on September 30 was at 2 times and 2.2 times on a gross basis. Shortly after quarter end, we completed the second amendment to our senior credit facility which provides committed liquidity now through October 2020 and on a lower annual cost.

Turning to our outlook for the remainder of the year, we are planning for current market conditions to persist with heightened uncertainty and reduced visibility into customer spending and order acceptance. Based on that expectation and our results year to date, we anticipate 2015 full-year adjusted EPS at or around the lower end of our previous guidance of $3.10 to $3.40, with revenues to be on the lower side of our previous guidance of down 10% to 15% range. The stronger US dollar that we have experienced throughout 2015 continues to present a significant headwind both to reported revenues and our earnings per share.

As a reminder, 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 expenses associated with our realignment efforts and below the line currency impacts as well as other specific one-time events, such as the first quarter's Venezuelan remeasurement and this quarter's valuation allowance. Regarding our realignment activities beyond SIHI that Mark mentioned, we now expect to spend approximate $125 million during 2015 and early 2016. This should generate approximately $125 million in annual cost savings, which will reach the annual run rate level by late 2016. From a cash perspective, we expect outflows of approximately $30 million in 2015 and $85 million in 2016 and the rest thereafter. With that, let me turn the call back to Jay.

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

(Operator Instructions)

Chase Jacobson, William Blair.

Mark, I was wondering if you could comment on the pace of the backlog burn? Obviously, I think it is pretty clear the short cycle work's been under pressure, but I would like to get a better understanding of how the projects that are in backlog are progressing relative to expectations? I know you mentioned that things are slower and some customers are pushing out shipments. This is kind of the normal, even in a normal market environment, but how much worse is it now and it was maybe a year or just on average?

In terms of your general comment around backlog burn, if you look at year to date, our book to bill has been relatively flat at one, which is certainly different form what we saw in the last downturn where you typically see a book to bill well below one. What is causing a lot of that to your point, is some of these projects, first of all, we're not the gating item or the bottleneck, as we have been a number of years ago. The fact is, these projects are ongoing but they're not running at a quick pace. Customers don't have the incentive to really take the product. They certainly don't want to start on site, because the product can tend to deteriorate, things can happen to it, ultimately.

We have seen that stretch out really during the course of this year. Not atypical when you see a downturn in the industry, because these projects are ongoing but the pace of them is slow. If you think about it, a project predicting a process is like getting a bond in place and you generate the cash flows from the processing of the refined -- or the refining product. They just don't seem too anxious to get these things online. We have seen that persist. We expect that will continue to persist some through the rest of the year.

Okay. On pricing, you mentioned a tough pricing. We have heard a number of different numbers from some of your peers, as much as 10% to 15%. Can you give any more color on what you're seeing in pricing and is it contained to the original equipment or is it also spilling into after market? Thank you.

Okay. Yes. It's primarily on the projects. Again, we saw this, just for everybody's benefit, because I think people are trying to understand how we're going to maneuver through this cycle versus the last time. Keep in mind in the last cycle when we came out, pricing was very robust. It's never really got near those levels during this last period, this last run.

The fact is, the first thing -- area where you see a lot of competition, this is around absorption of factories, these are big projects, these are the elephants that the sales organization likes to hunt, you do see a lot of price competition in that area. We have seen that along the projects, not as dramatic as last time, but that is where you tended to see the pricing pressure. On a lot of -- you do see some pricing on the run rate business, but keep in mind a lot of that is around being able to respond quickly. They are smaller dollar items overall. The after-market pricing has remained relatively stable.

Okay. Do you think that 10% to 15% pricing pressure is too much?

That is certainly something you would see on some of these big projects. If you remember, when we discussed project activity back in 2011, particularly in the Middle East, we would see pricing, when you go to final bid could drop 20% or 25% from where the bid levels were before. That is not unusual, particularly in the Middle East.

Robert Barry, Susquehanna.

I just wondered if you could offer a little more color on how you think we should interpret the better after-market bookings this quarter? I don't know if you are seeing some deferred maintenance resuming, for example, or if things just happened to trend a little bit better this quarter?

Here is a simple way to look at it. Year over year, parts tied to units is down. They are deferring a lot of what I would say are upgrade opportunities, they are like small capital projects around driving efficiency. There is some maintenance deferral. The offset has been continued execution on our end-user strategies. Over the years, a lot of the growth you have seen is just further penetration into existing customers, new customers, putting in new QRCs, taking advantage of the installed base. The market has certainly put a headwind to us. It has been mostly, not completely, offset by our execution of our end-user strategies.

Got you. And then, I had a question on the new cost reduction efforts. How much of these now $125 million in cost reduction efforts is assumed in your guidance this year? How does the cadence, how much comes next year versus say 2017? Thank you.

There is a little in the numbers this year we talked about. We did see one of our divisions got good early execution in the third quarter, FCD, so we saw a little bit of a benefit there. The bulk of this will come in a run rate basis next year. As Karen talked about, we expect it to be in full run rate toward the end of next year.

Also to my earlier commentary, I think I talked about two-thirds was what I would say is structural, in our view, is sustainable through cycles and a third was market reaction. Most of the incremental is more structural. We have responded to volumes and not that there is still not a little additional volume response we can do, but now what we're starting to do is focus on really bringing in systemic change in terms of the structure, reducing complexity. As Tom talked about, that will also go into our plant rationalization, product optimization. There is a lot of things we're working on and that we will continue to work on. The incremental is really our moving towards that direction.

Got you. Thanks, guys.

Steven Fisher, UBS.

You talked about the chemical feed, including some of the next round of the North American crackers. How, would you think, that next round of plants be different for you than what you experienced in the first round, if at all, just in terms of scope and overall magnitude of impact?

I would look at the scope as being very similar and the magnitude not much different. Obviously, we're talking about sometime in 2016 and possibly even 2017, the beginning of 2017 with those next rounds. There are two pieces. One is the new crackers themselves and then the second piece is the derivatives of the existing crackers that have now been built and now they are adding on additional chemical facilities to those. Those are the two pieces.

Okay. That is helpful. Tom, talked a little bit -- or you mentioned the reliability models. Can you just talk a little bit more about that and how big those might be and when we could start seeing some impact there?

That is, I would say, a fundamental change in a business model that we think long term is going to occur over time. That is where people get more of a driver on availability and reliability as opposed to just the cost. It factors in to total lifecycle of the product. We have gotten some good traction in our frame agreements in those areas and we are seeing a lot of customers begin to get more interested in that model. We have the set up to be able to do that in terms of the QRCs and the processes to bring them out to them.

Is this expected to potential be a swing factor for sales in 2016 or is it more longer term than that?

I would say it is a gradual ferreting in of that sales over time, with more and more customers moving towards that model, I would say, over the long term.

Okay. Thanks very much.

Joe Ritchie, Goldman Sachs.

Mark, my first question, you guys had really good gross margin expansion, especially in two of your segments this quarter and no incentive comp played some of the role there. How are you guys thinking about your ability to hold gross margins as we enter 2016, given the backdrop that you mentioned with OE pricing being down?

The pricing is going to put pressure on it. Unlike the last cycle, these projects are not a big part of our -- certainly the backlog and the revenue like they were then. There is no question the pricing environment is going to put pressure on the gross margins. On the flip side, we are looking at things like after-market mix in the business and then quite a bit of the realignment improvement efforts that are ongoing in the business. There is a list of things within the $125 million and then other things we're working on as well.

In general, though, you should expect that the pricing environment will definitely put pressure. A lot of our efforts are designed not only to respond to current market conditions, but we are trying to look longer term over the next couple of years at the margin profile of this business and drive even improvement off of where we were at peak levels.

Maybe as you are thinking about the restructuring efforts, how are you guys thinking about what portion of it is going to come through COGS versus SG&A? I know you gave us a two-third structural versus a one-third market related, but I'm curious, because clearly a lot of the restructuring benefits this quarter that we saw in FCD were coming through the SG&A line.

Yes. I t is roughly about 60 /40. I think as we look at additional opportunities it's going to tend more to the cost of sales because that is when we start rationalizing the facilities as well.

Traditionally, it has run in the 60% cost of sales, 40% SG&A. That is what we are expecting as we're going forward, as Mark indicated. The change that we had from the $100 million spend for the $70 million benefit, the change there is really due to the mix of the project. The original plan had a higher mix of closures and the updated plan that we have had more headcount reductions. The headcount reductions have that ratio of [1 to 1.3] of savings, about $85 million of that $125 million spend, or about $110 million of the run rate savings. Now that we have got an additional 5% headcount reduction in the [$125 million for $125 million], two-thirds of that spend now is headcount reduction. The closures have a ratio more of a 2.4 to 1, so about $40 million of the spend will be from about $15 million savings.

Just to follow-up on your question there with regards to compensation, looking at that from a comparative perspective, just to give you some information with regards to beginning to model that a little bit better, Q3 and year to date actual, if you look at just overall compensation, annual compensation, the impact will be about 100 basis points on Q3 and year to date through September. And then from a segment perspective, slightly larger in APD, lower in FTD, and then of course much lower in IPD.

That is helpful color. Thanks, guys.

Jonny Wright, Lenora

Maybe on the flow control side, I feel like the margin performance there is very strong. Can you parse out the drivers behind that and where you are looking at that into 4Q and in 2016?

So, if you look across our segments, you can see the margins were in EPD, were certainly impacted by declining revenues and less fixed cost absorption all across the SG&A line. It did have about 90 basis points of that bad debt expense is in the number there as well. As you work across that, a lot of that is going to be where you see the project activity and revenue decline and it is difficult to adjust the SG& A as quickly in that business. Held up a bit by the strong after-market component.

If you go across IPD, that is on the tail end of what I would say is our operational improvement in the business that you saw driving margins there. You also, including SIHI, saw, if you take out the purchase price accounting, some gross margin accretion and that is because the SIHI gross margins were higher and we're starting to leverage that as well. The real opportunity in our industrial segment right now is on the commercial side, is taking the platform we have, and we have got a significant opportunity to improve the way that business goes to market.

In the valve division, the simple message is they had a good quarter. It has been a very consistent performer, very, very efficient. It had a good power shipments this quarter as well. Its foundation is very, very strong and it is able to execute on the strong MRO opportunities, good power shipping during the quarter. In the aggregate, as you look across the Company, just cost control across the corporate expense. That is basically what you see in our margin profile.

Okay, thanks. I guess looking forward to 2016 then, you guys have talked about the incremental increase in the restructuring spend. As you sit there today, is the current plan looking to hold margins flat or do you think could margins could potentially offset the sales decline next year? What is the base case sitting there in a volatile market?

The end of your statement is just that, it is a volatile market. What we are trying to do is not only respond to the markets but prove the operating platform long term. As you look forward, a couple of things. As I mentioned earlier, relative to last cycles, while we see price declines in projects, they're not going to be as dramatic as they were in 2008 to 2009 because we had very strong pricing environment. That should indicate less of an impact relative to prior cycles.

As you look at our business overall, we have more after-market business than we did before and our run rate business has grown as well. The fact is, these are volatile markets. You don't know where your top line necessarily is going to come with these pushouts and with the order activity and that will tend to impact fixed-cost leverage. As you think through our business next year, a lot of it is going to depend on, the way I look at it, it is going to be the volume activity that we see. That is why I pointed you earlier to the fact that right now, we have a book-to-bill of one and we saw significantly less during this period of time in the last cycle, but we will have to see how that continues to flesh out over the next couple of quarters.

Great. Thanks for your time, guys.

Deane Dray, RBC Capital Markets.

I would like to follow up on Joe's question, and particularly Karyn's answer, regarding the impact of the change in incentive compensation. Was it 100 basis points, so that should flow through to the fourth quarter as well, but not necessarily into 2016. Is that correct?

As you said, it is all the way to line to our -- to shareholders. These aren't necessarily one-time items. We set up our compensation plans that really correlate to our commitments to our shareholders, particularly around our guidance. As we set that, if we over perform, as we have done in the past, that will tend to put an additional cost on incentive comp. If we under perform, it will put downward pressure, in a sense, on incentive comp. What to want to suggest is, this is the way we operate our business, similar to other things that you do in your factories to align your interest to the shareholders.

Okay. That is helpful. This is more of an accounting nit, we are trying to figure out where that $0.03 of bad debt write off, where does it show up in your results? I couldn't find it in the Q. Maybe you can share with us what happens and where we might find that?

It is in our EPD segment. It was about a 90 basis point impact on margins for the quarter. We took it in there. We did not adjust it out. It really relates -- the end user is certainly still intact but the way our policy works, as you talked about, after a period of time, if we have visibility, the contractor did go bankrupt, then we go ahead and take a reserve against it. At the end of the day, the product still may ship in the future because they needed for the facility the way we do our accounting, we took the charge.

Where would we have seen it discussed in the Q? We saw the announcement in the press release last night and the reference in the slide, but there was no other detail provided. Will we not see that discussed? Is it not material? I'm just curious for next time.

It was highlighted in the press release, so you can see the impacts on earnings per share on a consolidated basis. For materiality, for EPD, it is part of our normal reserve allowance analysis and didn't highlight it.

Understood. Thank you.

Nathan Jones, Stifle.

Mark, I just want to follow-up on Deane (inaudible) there, if you're looking at that 100 basis points for the year on comp, you're looking at about $40 million and as you said, that is largely levered to your delivering what you promise on guidance at the start of the year. So what is the kind of -- how should we think about how much of that comes back into expense next year, assuming you give guidance in January or February and you actually hit that number.

The way you think about it is, you have got a number of things in a comp. What we're doing is we're spending a lot of time on incentive comp, Nathan, but we have other things that go the other way. You have merit increases every year. I don't want to get too caught up in any one specific item, but the point is, you just take a step back. The way we design our comp is to -- is aligned with our shareholders. So when you look at our guidance at any given year, you should assume that we have plans right around where our commitments are to the extent -- and it is all interlinked. You talk about our annual increases, our annual incentive comp or our bonuses, our long-term metrics, they are all tied to the shareholders. The simple way to think about it is when we put a commitment out there if we exceeded it than we share the benefits with the shareholder. If we don't, then it goes the other way.

That's fair. I would like to attack the margin question for next year in a different way. If we break down your business into -- It's probably only going to be about 10% projects next year and say 45% run rate and 45% after-market. If the pricing on the projects is down 15% and say the run rate is down 3%, that would give me something like a 250 to 300 basis point head wind on margins in absence of anything else, so just taken in isolation. Is that a reasonable way to think about the pricing that is going to run through your revenue next year?

All other things being equal, that is of course the with the math would work. But if you see and mix shift towards more or less after-market, that will impact margins as well. The other thing is the cost savings, how they come through and when they come through. You can see once we get a run rate of $125 million, that is significant in terms of the margin profile. On last year's revenues, that is about 250 basis points of margins in and of itself.

That is a way to look at it. I think I have commented before when I referenced the last downturn is we saw the margins in the projects go down by literally 25%, 20%, 25% on, call it, 20% our business. That was significant. The math works but there is a lot of moving parts.

Thanks. That is helpful on that part. Can you just give us an update on what you expect for incremental savings in 2016 over 2015 before you hit that full run rate?

I think -- We have very little this year and right now we expect the full run rate to come in the end of next year. I know that is frustrating but let me tell you, when you deal with these things, they are anything but linear. We are talking about people, we're talking about various countries around the world. Those are what drive the timing and achievement of these savings.

The fact is, we just want to give you a general sense that we see a plan where we can execute these through the end of next year. I think it is important to point out, we're not going to stop with that. We still think we have significant opportunity in product optimization, certainly manufacturing optimization. You heard about our capital expenditures. We are acquiring a facility in China, or we are going to build out a facility in China, to move some of our valve manufacturing to. Over time, what you're going to see is that is going to help us further optimize our global platform.

I wouldn't expect you to be standing still, Mark. Thanks very much for the color.

Appreciate it.

Bhupender Bohra, Jefferies

I just wanted to -- if you guys can talk about SIHI. There was some commentary about improving gross margins over there and how the integration is proceeding right now.

It is going well. As Karen mentioned, it was basically flat to slightly positive, including purchase price accounting and if you take that out it was about $6 million positive. From an integration standpoint, as Tom mentioned, we have been able to use some of their very capable capacity to rationalize some of our facilities in too. I would say in general, the real positive has been the ability to leverage some of their capabilities.

We have learned a lot. We have learned a tremendous amount from acquiring this business and we're certainly excited about it. Not only in the results that you have seen, but in the potential of that business to globalize it. The comment I made around margins was historically, if you looked at our industrial segment, you saw roughly mid- to high-20%s in terms of the margins. SIHI had a higher margin profile, gross margins I'm referring to, in the low- to mid-30%s. That was my reference around the gross margins.

Okay. Just a follow-up with Tom on these new crackers which are coming up down in Texas. We were talking about the first wave and you mentioned about the second wave maybe in 2017. Just explain to us, at what point in the cycle does Flowserve actually participate? When to the projects or the products do actually go into these projects? Is it early cycle or late in the cycles of the projects?

I would say a little bit later cycle with the projects. Keep in mind that we sell different types of projects into that cracker in the residual plants that go in there. You could have a longer cycle project that may last eight months and you could have shorter projects that are three to six months. It's a varied amount of products into those plans.

Okay. Did we see that in the IPD? If you look at the after-market IPD, bookings are very strong X-SIHI and the FCD bookings. Was that factor over there?

Yes. I would say if you looked at SIHI, and I think Mark also mentioned, that there's about 80% of that business is run-rate business as opposed to large project. You are seeing some of that run-rate business hold up as we have indicated previously.

Okay. An y color on power end market? Final question.

If you look at the power market, there is a lot of activity going on with coal now, with the environmental requirements, so we are seeing a lot of coal plants being discussed in terms of switching to natural gas. That is one thing that is happening. W e are seeing, again, some environmental change outs in cold units themselves, which presents some opportunities. We are also seeing a combined cycle natural gas build out in a number of places around the world, which seems like it's beginning to get some steam behind it.

Okay. Thanks a lot.

You're welcome.

Brian Konigsberg, Vertical Research Partners

A couple of questions for Karen. With the discussion around cash flow and balance sheet, the leverage ratio traditionally Flowserve has been one to two times on a gross basis. With you coming in, are you thinking about that differently? Might you reconsider how you're looking at it including cash and maybe some of the priorities going forward?

Right now, no change to our financial policies that we have in place. We will continue to look at that but the stated target has been one to two gross debt to EBITDA. We have our regular dialogue with our Board regarding allocation capital and any decisions regarding our capital structure. We have use debt opportunistically over the last few years to right size the balance sheet and we used a source of funds for buying back shares. Over the past four years we have returned over $2 billion to shareholders through dividends and buybacks. This amount is significantly in excess of our stated policy over the longer term of returning 40% to 50% of our two-year net income to shareholders. We will continue to work through that, continue to be opportunistic, but we will continue to maintain a relatively strong balance sheet as we head into the markets that we're looking at.

Fair enough. And just separately, could you maybe talk about receivables? There has been, I guess, mixed data point about some of the national oil companies specifically and the bad debt expense you took in the quarter, just about getting paid by some of these customers that are under particular stress with oil where it is. Can you talk about your experience? Are there concerns that cash flow generation could slow down on the factor were are you seeing it differently?

We are seeing a little bit of a slowdown in terms of collections. In particular, in terms of our bigger customers, they continue to pay. At this point in time, we don't have additional reserves or concerns about ability and intent, otherwise we have booked incremental reserves above the one bad debt we have this quarter. AR is down overall, and primarily that lower sales and lower pricing. At this point, we don't have any significant concerns on anything in particular as we head into year end. We will continue to monitor that from a credit perspective and are very, very diligent around.

Great. Thank you.

William Bremer, Maxim Group.

Tom, the question is regarding downstream activity and you voiced of we are all seeing many of these refineries at or close to (inaudible) capacity. Would you be able to give us a little more granularity of what you're seeing here domestically and what you are seeing internationally and how that affects your business?

Bill, I would say overall the MRO activity on the downstream I would say has held up reasonably well versus the prior sequentials. We are pretty pleased with that aspect. I would say in some of the businesses, like the valve business, they have done pretty good on the after-market control valve business relative to the petrochemical area. We are pleased also there. I would say overall on the after-market good, I would say steady performance over the last three quarters, given everything that is going on in there. Relative to the North America, we still see deferrals happening, but we still have our fair share of the after-market business.

Excellent. One for, Karen. You mentioned the DSOs came back a couple of days. The last quarter question voiced whether or not you were able to pull it more levers there and given the pricing now and some of the end customers, should we just make the assumption that DSOs pretty much hold this type of level going forward?

The Company continues to make, I think, a lot of progress in terms of working capital, in terms of the approach to it. For example, from it accounts receivable perspective on a systems level, some really solid progress in terms of generating reporting tools that help to focus on collections. One of the things we're looking at right now is really moving that focus from the site level, where we they're driving improvements in terms of collections, to really generate more meaningful improvement in working capital. We intend to take a global approach and focus on the entire end-to-end process.

So to your question, yes, I think we are probably going to level out here a little bit in the short term, but in driving a more wholesome improvement, we do expect to lever the tools that have been created to date and the work that has been done to date, but in order for us to drive a more dramatic improvement in working capital, we intended to standardize terms and dedicated global collection team, automate dispute management, drive further discipline, complaints all the way through the entire sales process. We plan to implement a global standardized procedures which will range from order to entry to billing to cash application from purchasing to payables and from record to report. As you put out these standard procedures in place globally over time, we would expect sustainable meaningful improvements, but it will take some time.

I look forward to it. Care to give us a target?

These types of shared service type models can take around two years or so to build. We would expect to see some tangible benefits within the first 12 to. 24 months, but real sustainability, once all of the site are rolled out and everything back integrated, it is going to take up to about two years.

My final question is on the underlying tax rate. You voiced the reason why it jumped a little bit this particular quarter. Going forward and into 2016, where should we place it?

We are still expecting to be in the range of around 30% to 31%.

Great. Thank you very much.

Joe Giordano, Cowen and Company.

Most of my questions at this point have been answered. Maybe if I can ask you about bid-ask spreads in the M& A space right now, particularly on some energy assets. Have we seen after the second leg down kind of a reevaluation of sell-side expectations there?

In general, what we have seen is on the smaller ones that are privately owned is the sellers are still looking for recent prices that they have seen. It just takes a little time for that to adjust out of their thinking. These are often family-owned businesses they started, they've have been involved with for a period of time. Unless they have some real urgency to exit the business, they will tend to have long memories on strong markets and short memories on weak markets.

Larger properties a bit more rational?

No. We primarily had been focusing on the bolt-on space, but you have seen what has happened generally overall with some of the other flow control assets and how they have moved.

For sure. Thanks, guys.

David Rose, Wedbush Securities.

I just wanted to follow up on the backlog and margins and just get a better sense in terms of the last time it took a while to work through backlog. You had some pressure on margins as the longer the product fit in backlog. You have done a lot of work on documentation to help expedite this. Is there a potential risk that we have got these lower margins and therefore a protracted period of time? Maybe you can kind of handicap for us what you are seeing as products are delayed, what the impact is on your existing margins?

Yes. I don't know if you were comparing -- the last time, some of it was our fault around execution that extended the terms and backlog. We have significantly improved on that. The fact is that the backlog relative to where we were in the last cycle and projects is lower. There is less to actually flow through over that period of time, so what you see in our backlog right now is more of a mix of run rate business and after-market. Having said that, as you have seen this in the oil industry, last time oil snapped back relatively quickly and these projects -- there was still a sense of urgency to get these products online.

One thing that is different is we're certainly seeing that these projects are not running at a pace in terms of delivery that they were before and even slower than what we saw in the last cycle. I think the risk is, and we have seen this during the course of the year, is that the backlog, the delivery can extend, we're not going to worried that they are going to go away because a lot of these projects are well underway, but we could see where customers can push these things from quarter to quarter an in fact we have.

To your point, what that's going to impact, obviously project backlog is typically, and almost all instances, your lowest-margin backlog, if it gets pushed you could say that can help margins the fact is, around the project or the gross margin in and of itself, but it does impact revenues. This is what you're seeing in the EPD segment, is the revenue declines, it was difficult to offset with reduced fixed costs so you lose the fixed-cost leverage in your operating margins.

Okay. That's helpful. If we can segue into the inventory side of it. Maybe you or Karyn can provide some color on what you are doing to better manage the inventory in this environment?

Part of what you see, and you can see it in our -- in some of our supplemental disclosures in our 10-Q, is when projects tend to get delayed in terms of delivery, you see a build in work in process and finished goods. A lot of these projects are work in process, so they will tend to build there from an inventory standpoint.

Thank you.

I would add relative to supply chain, we have efforts going on in terms of making sure that the material's coming in at the appropriate time to the facilities, we look at the cycle time on our products and we always gravitate on projects relative to cost reduction and/or cycle time and you will see probably a little more effort on our part in terms of our research and technology area gravitation towards lead times and driving more time out of the business that way. A lot of effort going on in the supply chain right now.

Thank you. Our last question is from Ryan Connors of Boenning and Scattergood.

I wanted to talk about the water business. It's something I hadn't heard you mention a quite some time in your prepared remarks and yet you did so this time a couple times. I think Mark and Tom both mentioned desal. Can you span on that for us a little bit? Where exactly are using that? What types of projects those are and what the materiality is or where you thought it was worth noting?

The water and wastewater business was up not too much. It was up almost about 3%. It's a small percentage of the overall piece. A lot of our desal business is categorized in our power business. We are still seeing some good opportunities in the desal Middle East, India and while that business has not returned to the levels that it was it is, it's constantly, I would say, always in the background. We are now starting to see some early feed work starting in that area. The expectation is that there would some movement towards moving that now through proposal stages as the EPCs get done with their evaluations.

Okay. And I will throw this out there as well to see if you have any comment. That Calder business is essentially a duopoly. Your biggest competitor there had a pretty big notable development in the quarter. They signed a nine-figure deal with Schlumberger to basically market a fairly similar device that they had adopted for down-hole drilling and fracking. They claim it is going to reduce (inaudible) dramatically there. Is that something where your team is looking at that as something you can adapt to your products as well, or is that -- or had you seen that, or any comment there?

We certainly see that as an opportunity but, obviously, as you can tell from them, they are ahead of us on that.

Okay. Great. Thanks for your time.

We have reached our allotted time. Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.