福斯 (FLS) 2016 Q3 法說會逐字稿

Welcome to the Flowserve 2016 third-quarter earnings call. My name is Paulette and I will be your operator for today's call.

(Operator Instructions)

Please note this conference is the recorded. I will now turn the call over to Jay Roueche, VP of Investor Relations and Treasurer. You may begin.

Thank you, operator, and good morning, everyone. We appreciate you participating in Flowserve's 2016 third-quarter earnings call. Joining me this morning are Mark Blinn, Flowserve's President and Chief Executive Officer; Tom Pajonas, Executive Vice President and Chief Operating Officer; and Karyn Ovelman, Executive Vice President and Chief Financial Officer. Following our prepared comments, we will open the call up to your questions.

As a reminder, this event is being webcast and an audio replay will be available. Please be aware that our earnings materials do, and this call will, include 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 in both our press release and 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 28, 2016. 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 earnings materials as well as our other 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. Good morning, everyone. Let me begin by reviewing some of the key headlines from the third quarter, which we will cover in greater detail as the call continues. First, on the positive side, we are pleased to achieve a book-to-bill greater than one for the first time in over a year. This is a particularly positive development, given that our customers continue training cautious and deliberate with their budgets and spending patterns. As a result of these bookings, our backlog grew modestly and higher-margin aftermarket bookings now represent over 30% of our work under contract for the first time. We are also seeing some early signs of pre-feed and feed opportunities building in the pipeline.

We are particularly pleased with the bookings' resiliency and performance of our aftermarket franchise throughout 2016, producing modest constant currency bookings growth for the year. We continue to make significant progress on our ongoing realignment program, which will drive cost out of our platform and a position Flowserve to enhance profitability as a leaner and more efficient Company. Finally, while our third-quarter earnings were lower than expected, the Company continues to be well-positioned and we are actively pursuing opportunities for further improvement as we execute on our cost reduction initiatives and long-term strategic growth opportunities.

With regard to market and Company-specific challenges this quarter, we continue to experience challenging global macro conditions and, as I noted earlier, our customers have remained cautious and deliberate in their investment decisions. Reflecting this environment, project delays, rolling maintenance deferrals, and extended timelines for both order placement and delivery acceptance have become the norm. We were particularly surprised at September with the slow pace of industrial short cycled and aftermarket revenues, but the good news is these orders remain largely in backlog and we expect to deliver on them in future periods. There's also additional political uncertainty in many regions around the world, including the United States.

We continue to see some operational and cost issues in our receiving sites as we shift manufacturing and implement our structural realignment program. However, we are actively addressing these issues. While we are pleased with the progress in our aftermarket bookings, the lower backlog associated with our OE facilities will increase under absorption in the short run, which occurs faster than we can realign or take costs out. As we execute a computer realignment plans, our new cost structure should catch up to the current workload and alleviate this timing issue and position Flowserve when the cycle improves.

Finally, we incurred some significant non-cash reserves during the quarter related to Latin America. As we have previously discussed, this region has been, and remains, challenged. While we have collected about $5.5 million year to day and will continue to actively pursue collections on these accounts, which are not dispute, we believe that fully reserving for certain receivables balances and work in process is the most prudent course of action.

On an adjusted basis, EPS this quarter was $0.52. While we indicated our last call that we expected this quarter to be light due to the timing of shipments, given the magnitude of this impact, along with the continuation of challenging market conditions, we are revising our full-year guidance. Karen will cover our financials in more detail, but operationally we will continue to focus on a disciplined approach, cost management and improving our efficiency across the business and addressing all of these with a sense of urgency.

Despite the challenges this quarter, it is important to note that we have successfully navigated previous cycles and are actively leveraging this experience as we manage our business through the current market environment. Further, I am confident that our current strategic direction and ongoing cost reduction initiatives will positions Flowserve competitively for the eventual recovery in our energy end markets.

Our primary near-term challenge remains transforming our manufacturing platform quickly enough to reduce under absorption while enhancing our operational flexibility to meet customer expectations of better value for their investment dollar. This situation particularly impacts EPD and IPD in the near-term, as pump OE backlog continued to decline during the period. With the recent operating issues and financial performance in our IPD segment, I have asked Tom Pajonas to assume interim leadership of the segment's day-to-day operations. Tom was instrumental in turning FCD into the stronger performer it is today and I am confident that he will drive the necessary actions and accountabilities to improve the business.

Key initiatives include accelerating the pace and execution of the realignment program and embedding sustainable process improvements to drive differentiated value for our customers, such as reduced lead times, automated order process through e-commerce, enhanced supply chain management and improving on-time deliveries. Ultimately, we are driving towards an operating platform and culture in IPD similar to that of our FCD segment. I have complete confidence Tom will improve IPD's performance with time.

Next, I'd like to update you on the significant progress we're making as we execute our realignment program. Though we continue to have some operational issues in some of our receiving sites, we are continuing to focus on the structural transformation of our business platform. During the third quarter, we initiated actions to close two additional manufacturing facilities, including an Australian IPD facility which will be consolidated into another Flowserve site in that country and we are transferring EPD's Lawrence operations based in Massachusetts to other US and Latin American facilities.

During the fourth quarter, we plan to address additional manufacturing sites, including recently announced initiatives to close a German manufacturing facility and the consolidation of Middle East QRCs. We continue to expect about $160 million in charges for the year. From a savings perspective, we delivered approximately $37 million in the third quarter, $80 million year to date, and importantly, we remain on track to deliver $100 million of incremental savings for the full year of 2016.

While we identify most realignment costs incurred for your analysis, I'll reminded that our reported and adjusted numbers do not include the expected negative impact on revenues and profits that have been delayed during the transition, which should materialize as receiving sites come up to speed on the new lines. We are improving our manufacturing transitions with dedicated resources and teams to minimize bottlenecks and implement processes to apply lessons learned from completed actions as we continue to execute on our realignment program.

Turning to our markets and bookings within our served industries, overall we believe the relative stability of oil around the $45 to $50 range over the past six months has been a positive development for many of our customers. Nevertheless, we still anticipate that our customers will remain cautious with their capital and operating budgets in the near term. In considering the multi-year nature of infrastructure original equipment investment, it will likely require several quarters of this level of stability before investment spending actively resumes and we expect the opportunities that arise will be competitive.

Overall for the quarter, constant currency bookings declined approximately 7%, primarily due to an OE bookings decline of approximately 11%. As expected, aftermarket bookings continue to demonstrate resiliency, but did decline approximately 2% this quarter. While aftermarket bookings have increased constant currency year to date, third-quarter aftermarket sales saw a sharp drop-off sequentially during the quarter. We believe this is just a timing issue, as it is rare for aftermarket orders to cancel and was mainly because our first-half 2016 bookings included a few upgrade projects that will not ship until 2017.

Additionally, some customers have been slow to accept shipments, but we do continue to see elevated levels of emergency response aftermarket opportunities. While pricing pressure has been a significant issue on larger CapEx driven greenfield and brownfield projects, we are pleased that we've maintained fairly consistent pricing levels in our aftermarket bookings.

Turning now to specific end markets and looking at bookings on a constant currency basis coming off a low base, bookings in our largest served market, oil and gas, increased 10% in the quarter. European orders and an ebulliator job for Asia were key drivers of this growth. While we are pleased with this improved level of bookings, we are certainly not calling a bottom yet. However, we do view our downstream and midstream focus as a long-term asset for the Company. Power bookings decreased approximately 21% on a tough prior-year compare. Going forward, we expect steady combined cycle investment in North America and fossil projects in Asia, which tend to be very competitive.

China continues to invest in nuclear, where we participate in both the Western and Chinese designs. In our general industries, constant currency bookings decreased approximately 4%. The distribution channel remained depressed in the quarter. While we continue to believe destocking across many of our distributors is largely complete, distributors overall are maintaining lower inventory levels, pricing smaller orders, often only when they have a customer order in hand, so a quick response time will be a priority for us.

Chemical bookings were down 18% the quarter, with low levels of new project releases. We continued to see delays in the expected ethylene driven derivative plants, as well as the second wave of crackers, but we expect this development to progress in North America and the Middle East, supported by low cost feed stock.

To summarize the quarter, we remain focused on rapidly transforming our cost structure for these uncertain markets, while positioning Flowserve for enhanced growth and profitability. We've seen cycles before and fully expect our markets will recover. Importantly, we are confident that our investments to improve the competitiveness and efficiency of our global operating platform will lead us through current challenges and enhance the value that Flowserve can deliver to our customers and shareholders.

Finishing up on a personal note, as most of you know about a month ago we announced my intention to retire from the Company at the end of March 2017. After over a decade of Flowserve and as the Company begins its next phase of growth and development, now is the right time for the Company and me to begin this transition process. I am confident that Flowserve has the right strategic plans and the right team in place to achieve our objectives. Flowserve is a great Company with a solid operating and financial foundation and is on the right path forward. Importantly, until the Board names my successor it remains business as usual and I remain fully committed to the success of the Company, our employees and shareholders. With that, let me turn the call over to Karen.

Thank you, Mark. Good morning, everyone. Turning to our 2016 third-quarter financials, as Mark noted, our operating results were primarily impacted the continued challenging market environment and various associated factors, including Latin America, our realignment initiatives and our performance of the OE business, which I will detail. Third-quarter adjusted EPS of $0.52 excludes $0.47 of non-cash charges related to the Latin American activity, including a $63.2 million charge to reserves certain undisputed accounts receivable, which we will continue to pursue and a $15.9 million charge to reserve for inventory exposures in the region.

Additionally, adjustments include $0.21 per share of realignment expense, $0.01 associated with SIHI purchase price adjustments and integration charges and a gain of $0.01 on below-the-line effects FX. Reported loss per share for the quarter was $0.16, which included an above-the-line negative currency translation headwind of approximately $0.02 in both reported and adjusted EPS. Q3 revenues of $943 million decreased 14%, or 12.1% constant currency. Year to date, Flowserve's constant currency revenues decreased 8.2% compared to 2015 levels. Regionally and a constant currency basis, North America was roughly flat, while the Middle East and Africa, Europe and Asia PAC were down low- to mid-teens. Latin America remains our most challenging region, with a decline of nearly 39%.

Adjusted SG&A expenses declined 10% in third quarter but remained elevated as a percent of sales due primarily to the decline in revenues and the timing of expected realignment savings from our ongoing realignment program and our paced approach to SIHI cost reduction. Additionally, we have continued to invest in aftermarket and distribution initiatives as we focus on long-term growth in the business.

Turning to margins, third-quarter adjusted gross margins decreased 350 basis points to 32.4% versus prior year and excluded $15.9 million of non-cash charges related to our Latin American activity in realignment charges of $24.5 million. Reported gross margins were 28.1%, negatively impacted by increased under absorption on lower volumes, the adjusted items and further challenged by shipments that reflected the pricing environment booked over the last year and a half. Adjusted operating margin of 11.7% excludes non-cash Latin American charges, $79.1 million, $31.5 million of realignment and $2.6 million of SIHI charges, partially offset by realignment savings and lower compensation expense.

Both gross and adjusted margins benefit in the quarter due to lower variable incentive compensations in the 2016 quarter as compared to a year ago. In total, we had over 100 basis point operating margin tailwind year over year during the third quarter as a result of this line item. On a year-to-date basis, however, variable incentive comp is, and is currently expected to remain, a slight headwind to our results. Our third-quarter adjusted tax rate of 29.3% was slightly below our full-year guidance rate of 30% to 31%, due primarily to the jurisdictions where earnings occurred.

Turning to our bookings, constant currency original equipment bookings declined 11.4%, while our aftermarket franchise remained relatively stable, down 2.1% over the prior year, but still showed modest growth year to date. From a regional perspective, Europe and Latin America constant currency bookings increased 7.9% and 7%, respectively. North America was down 6.4% while Asia-Pacific and the Middle East and Africa were down in the mid-teens.

Shifting to our realignment program, we realized approximately $37 million of savings in the third quarter, bringing the year-to-date total to approximately $80 million. With our continued progress this quarter, we remain on track to achieve our goal of incremental savings of approximately $100 million in 2016. We expensed $37 million in the third quarter related to these efforts, bringing the first nine months 2016 total expense to approximately $70 million and we continue to expect total program savings of $230 million at a total program cost of $400 million. We further expect total 2016 cost of $160 million.

We continue to strive for efficiency in our investments in as we progress our efforts, we will continue to assess individual projects within the program to adjust or replace initiatives within the framework to which we have been externally guiding. We continue to estimate total savings of $195 million in 2017, which is $70 million incremental to total 2016 program savings of $125 million. In 2018, the full annualized program savings are expected at $230 million.

Turning to cash flow, through September 30, 2016, operating cash flow is down about $73 million versus a year ago, primarily due to decreased earnings, partially offset by working capital improvement. In the third quarter we returned $25 million to shareholders through dividends while our realignment program used approximately $30 million of cash. As many of you know, the fourth quarter typically accounts for a substantial portion of the year's operating cash flow and we expect this seasonal trend to occur again in 2016.

Turning now to our outlook for the remainder of the year, based on our first nine months 2016 results and our expectations for the fourth quarter, we have updated our 2016 adjusted EPS guidance to $2.05 per share to $2.25 per share. Unexpected revenue declines of 11% to 14%, including a 2% currency headwind, or roughly $0.10 per share, of above-the-line impact. Guidance further assumes net interest expense in the low- to mid-$60 million, a tax rate of 30% to 31% and reduced variable compensation expense.

As a reminder, our 2016 adjusted EPS guidance includes the operational performance of our 2015 SIHI acquisition and excludes realignment expenses. In addition, the Latin American non-cash charges recorded in third quarter, SIHI purchase price accounting and integration costs, below-the-line foreign currency effects and the impact of other potential discrete items are also excluded.

Moving on to cash uses for the year, we continue to expect full-year capital expenditures in the range of $105 million to $115 million, a significant reduction over elevated 2015 levels. Cash realignment expenditures are expected in the range of approximately $125 million to $150 million for the full year. We have $15 million in scheduled debt payments in the fourth quarter, bringing the full-year debt reduction total to $60 million. We contributed $20 million to our fully funded US pension plan through the first nine months of the year and we anticipate no further contributions in the fourth quarter. With that overview, let me turn the call back to Jay.

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

Charlie Brady, SunTrust.

Thanks, good morning.

Good morning, Charlie.

A couple questions really on the realignment program. First you talked about accelerating some of the efforts that are going on there and I guess my question really is, there's currently some inefficiencies going on with the realignment and moving factories from one place to another. Is there -- does accelerating this program in your mind increase in operational risk, or what are you doing to mitigate that. I guess my second question related to that would be, you talked about the absorption, the realignment savings not really overtaking the absorption right now. Is there a time you can provide us when you think, kind of ballpark, when you think that switch over might happen when you kind -- I know it depends on the volumes, obviously, as you go into 2017, but maybe some idea of in your mind of when you kind of get that crossover threshold to where you're making up for the absorption on the lower volumes

Let me start with the latter one. A lot of the absorption issues are going to be in a large custom engineered facilities those are also the ones that take time to effect the realignment, primarily, Charlie, because you have backlog that you need to work off. You need to carefully transfer those product because they're very highly engineered. There's all skill set needs to move, a lot of capabilities so we anticipate a lot of those benefits from the custom engineer to come through next year and this was anticipated at all times as we worked off the backlog. We expect that efficiency to start or to work its way through in 2017 and that will help offset because a lot of the backlog decreased that you're seeing is in these large projects, though it works somewhat in parallel as we work off that backlog and that's primarily what you've seen in our bookings decline, that those costs start coming out of the business.

To your first question, I think the general comments were, you always plan for some inefficiencies when you're moving product. Is not like moving simple-widget manufacturing. There's a lot of know-how. There's product movement. There's a lot of planning that goes into it so there is going to be some slippage. It is not insignificant, but you plan for it. In fairness, and I think we've been very upfront, in the IPD segment, we've seen more than we anticipated and in what that does is that impacts a couple things. It will impact results. It will also impact bookings as well, because if a plant isn't operating efficiently, you can't book into it.

In my comments earlier, that's why I said Tom has taken over. Your questions was the answer and it's proven in the past it's Tom. He's assume the responsibility for that and getting these things resolved and I'm confident that he well. Clearly, the -- in general realignment is going as planned but we've seen some impact beyond what we anticipated, not insignificant, in the IPD segment and we will fix it.

Thanks, Mark.

Scott Graham, BMO Capital Markets.

Hey, good morning, all.

Good morning, Scott

Mark, first of all let me congratulate you openly on your retirement. On your watch this has become a much better Company. While that's not reading through now, I have no doubt that will when the end markets improve. I only wish your exiting at a time when the operating environment was better, so congratulations.

Thank you, Scott. I appreciate it.

I have two question for you guys. The first one is about pricing and particularly given your comment, Mark, that even when things do get better, you expect some pretty competitive bidding out there. Pricing is obviously down on a year-over-year basis. Would you expect it to continue to be down, maybe though by a lesser amount in 2017?

Well, let me separate this a little bit. On the big projects, until backlogs start to get full, I think you are going to see pricing pressure. Just remember in 2013 and 2014, factories weren't full in our industry so you didn't have the kind of, near the 2007, 2008 time of pricing of environment that you have -- you had at that point in time. If you look at these custom engineered facilities, our industry is taking capacity out, so what you'll see is that capacity that is remaining will become taxed quicker, but you need to start to see the pickup in the custom engineered and large projects. As I talked about before, and in my comments, you see some early feed work that's being done but as we commented before, we don't anticipate that, that would come into our industry's bookings until the end of next year or 2018.

Now, when you look at the other parts of our business, and this is why we talk about a lot e-commerce on-time delivering, a lot of pricing there is about being able to respond to the customer, because these aren't large, highly competitively bid type projects, this is about getting the product that the customer needs to him as quickly as they can and making it easy to do business with them. That's -- we see that as an opportunity. For example, I talked earlier about IPD. If we can respond and respond quicker you can get price. You can not only get price, but you can get volume, so that represents an opportunity for us.

Then in the aftermarket business, I think we've commented everybody's looking at their OpEx budgets. We're, in this oil and gas, we're in the ninth quarter, so folks have gotten fairly focused on their OpEx budgets and continue to do that. But again, a lot of that is about being able to respond very, very quickly. We've been pleased to see somewhat that there's been stability or reasonable fair stability in the pricing in the aftermarket business. The way I'd look at it is, the projects, I think they are going to remain competitive until you start seeing some more robust bidding activity. Keep in mind that the industry capacity will be less than a was in 2014. As to the other ones, I think a lot of the pricing is in our hands.

That's a good answer Mark, thank you. The follow-up question is a simple. It's fourth quarter, the guidance assumes a lesser decline in operating margin than in the third quarter. My guess is that, that's largely based on the ease of the comparison or something else that you would point to?

I think is going to be volume. If you note historically, Q4 is our strongest quarter, so we get fix-cost leverage. I'm very pleased. If you look at our adjusted SG&A, we were below $200 million and we haven't seen levels of that in a number of years and the a lot of that is some of the realignment but I also I think just the cost containment efforts that we've pushed through our business. A lot of that is going to be volume with fixed cost leverage. It permeates through the entire P&L, because of absorption issues and things alike. That's why.

I got you. I did have one other question there and I forgot. I'm sorry.

We can follow up if you need it.

That's fine. No problem. Thanks.

Thanks, Scott.

Andrew Kaplowitz, Citigroup.

Good morning, guys.

Good morning.

Mark, can you give us a little more color into your aftermarket sales in the quarter? If I look at aftermarket bookings, they stayed in the range of $450 million to $500 million, at least in the last couple years, but you mentioned that sales were low, took a step down. You talked about short cycle industrial weakening in September. How should we think about aftermarket business moving forward? Can you quantify how much in sales were the delayed aftermarket shipments that won't ship until 2017? Do you see the aftermarket more stable? The bookings were flat. Are you concern that the weaker sales number could continue for a while?

Well, I mean, there is a difference between the bookings and sales in the quarter. I think you've seen this in our industry, that there was a slowdown and for many expected, because you saw all the adjustments that occurred. This is one of the lower aftermarket sales we've seen in a while. I wouldn't call it systemic at this point in time because in my comments you heard we haven't seen large cancellations. I think there was just, it was a slow pace. If you look at the third quarter in our industry, there's a lot of vacation time in July and August and there needs to be a notable ramp up in September and we didn't see it. Now, we're certainly considering that in the guidance for the rest of the year, but we haven't fundamentally seen a structural change in our industry were people have no interest in taking any aftermarkets. Remember where those things go. I think the bookings pace is still something to keep in mind of, but in fairness, we will tell you, our aftermarket sales were low in the quarter.

Is October acting like September or is it too early to tell?

It's too early to tell and even Q4, and again, this is why we were cautious in our guidance. Q4, December is an important month as well. Andrew, if you look at things with the election and all the things that are going on around the world, you can see why the world kind of took a pause in the third quarter, but we'll see how it comes out in the fourth quarter.

Got it, okay. Mark, there's obviously a ton of moving pieces in your earnings, but maybe you can frame how to think about 2017 at this point. I know you don't want to give guidance or your backlog (inaudible). It's been relatively stable now for about a year. It is down still significantly year over year. Aftermarket we just talked about. You should have increasing savings from your realignment plan. Hopefully IPD is going to start getting its act together. Can you talk about your conviction at this point that 2016 was the bottom?

That's a good way to think of it. You are right. We are three months away from giving our guidance so I certainly don't want to do now because we are working our plans as we speak. I think as you look forward, I mean clearly, our lowest contribution margin business is the one that is seeing the bookings decline and that's our custom engineered. While that is coming down, that is where we are addressing the realignment and if you think about our business, that doesn't, that industry has absorption issues but not necessarily the biggest contribution margin. It is certainly being impacted. In that you're also see the mix of aftermarket run rate become a higher mix. Aftermarket backlog represented 30%-plus for the first time really ever in our business.

Also as you look forward, I mean you talked about the IPD, getting to work on that. There is good opportunity there. Just look at its historical performance. SIHI's a good business and Tom's on the matter in terms of the opportunity going forward, the benefit of the realignment. Then on the flip side is companies deal with inflation and as we talked about before, around the variable comp, but that's aligned with our shareholders. I think those are all high-level factors to think about when you look at our business and then ultimately what happens to the market.

Good. Thanks, Mark. Congratulations on your retirement.

Thank you very much, Andrew. I appreciate it.

Deane Dray, RBC.

Thank you. Good morning, everyone. Mark, I'd like to start that observation about rolling MRO deferrals. We've heard this from a number of your competitors, so it's not a Flowserve, issue it's a sector issue. We understand that. Your perspective on how much the MRO can be deferred. Some cases you run into plant safety issues so forth, but is this what you expect the duration for at least this (technical difficulty).

Generally our sense is that this MRO role is in a kind of steady cadence and from this point, if there's more confidence around the OpEx, it will start to abate some. I think you're right, Deane, it does become a safety issue. There are planning issues around takedown. Keep in mind, a lot of these plants have to be taken down on specific repair schedules because if they don't, you definitely run risk. As I mentioned earlier, being two years into this, I think a lot of that deferral is kind of on a steady cadence. We haven't seen a pickup in it. We have in terms of that data abating, we have seen of emergency opportunities come up which customers don't necessarily like to have. I think we're on a steady pace and I think what will happen over time is that it will abate. It will not abate all in one quarter, because they just can't pick up their maintenance and service schedules that quickly. I think it will steady -- it will abate steady to a more normal pace in terms of MRO planned takes down in facilities, upgrades, repairs all those things.

Sure, that's helpful. How about go back to the fourth-quarter guidance if we could. That's an awfully wide range. We understand that kind of uncertainty that you're dealing with right now, but it would be helpful if you give us a sense of what would be the key assumptions that would put you at the low end and also at the high end of the range

Well, I mean, we take into consideration if you look at what you heard from industry, how the quarter and particularly September impacted them and how that impacts into seasonality. If you look at our fourth quarter, typically our fourth quarter is our strongest quarter in our industry and for our Company. Just looking at the potential variability of outcomes, that's how we drove our guidance. If there's normal season, that impacts our guidance in one way. If we see any kind of reservation concern drop off, that's where we took it to the bottom end. If you look historically, we've had a range roughly here and we typically will be provide guidance in January.

Exactly. That's -- we should expect that, that you'll have more precision then?

We typically do. Again, that's three months away so I don't want to get ahead of that but that's typically what we've done in the past, Deane.

Got it. Thank you.

You're welcome

Mike Halloran, Robert Baird.

Good morning, everyone, and congrats on the retirement, Mark.

Thanks, Mike.

First on the backlog and then thoughts into next year. Is there any reason to think that backlog wouldn't kind of have its normal bleed in the fourth quarter? In other words, does guidance assume that you have a normal backlog bleed off or dump in the quarter? If that's the case, as you go into next year, then short cycle aftermarket is probably going to be the key. Some thoughts on where you'd see it first, what customers are telling you and what it would take for that to turn around?

Yes, so Mike, you are right. Typically we have a book-to-bill less than one in Q4 and a lot of that is around the seasonality of our business. I mean, obviously it's going to depend on our Q4 bookings. That's one of the components of the book-to-bill. It's fair to say, you're right in what you've talked about. Where we've seen the primary bookings decline are in the larger projects. That also correlates to where we're taken a lot of our aggressive realignment actions to address that. As we look into next year, it is going to be more the short cycle in the aftermarket. The things that as I look into next year that are going to impact that is obviously the work Tom is going to do in the IPD business, because I'll remind you, bookings in that business have not been insignificantly impacted by some of the challenges that it's had this year and particularly in the over last two quarters.

Getting back to the earlier comment about where we are in terms of maintenance cycles that will impact the aftermarket business. Where companies are on the OpEx budgets to do some small upgrades and efficiency repairs, which are sorely needed out in the industry right now. If you think about our business, there are levers certainly we can pull, both from what I'd say a commercial sales standpoint around e-commerce and making it easier to order our products, which customers want to do and they want to do quickly and they have -- we have fairly good pricing power, to the operational improvements, how the market responds in terms of their OpEx budget.

We're -- the one thing with time and being in a down cycle is that brings one day closer to when you start to move out of it. We're pretty far into this. If you think about our industry had a relatively strong cycle for -- on and off, but for the most part on, for about a 10-year period, we've been in a two-plus year downturn in the industry. That's quite while. While that's not great from a retrospective standpoint, if you look forward, it does bring us closer to when this will start to abate and we'll move out of it. I think one thing I'll remind you, we taken a conservative approach on our future in terms of our actions. We don't think pricing is going to come back to 2007, 2008 levels. If it does, we will be all the better off for it.

For just puts and takes on the margins into next year, you've already at least loosely talked about pricing. Obviously a lot of confidence in the interval initiatives and then volume leverage that you leveraged depending how that pans out. Any other puts and takes we should be thinking about, changes in incentive comp going to next year, pension, things like that?

Not any large item. On the incentive or the variable comp, it's that. It's how do we deliver to our shareholders and what commitments do we make. It's other cost containment. If we look at issues around inflation in the business, all the things that I've talked about, we do and always have been reacting to that to look for ways to drive efficiency in our business. I think the items at a macro level to think about are, how can we respond to a declining project environment before it starts to pick up with our realignment efforts? How can we drive our realignment efforts that are on the table in the other areas as well?

Improvement in our business, particularly in the IPD business. Continue to look for efficiency and then just dealing with inflation that all companies deal with and the variable comp, how we set it. Probably a good high-level way of thinking of it and then starting to realize, really -- oh, I think there's one other element is in our CE business. That is still have an impact on our SG&A and as I commented earlier, adjusted we're below $200 million. We will get that out next year. It's a good business and we're learning a lot from it.

Great, thanks, Mark. Good luck.

You're welcome, Mike. Thanks.

Robert Barry, Susquehanna.

Hey, guys, good morning. Actually just wanted to start with a follow up on an earlier question. You had referenced some elevated levels of emergency repair activity. How widespread is that and in has that been accelerating?

Not really. I think it's just what happens when you stretch it out too long. These operators are savvy and they know their plants very, very well. Typically they will not manage those to the point where they created a state of disrepair, but it does happen. It's more isolated, you see that. In general, when you see rolling deferrals, that does tend to increase those they're not perfect at pushing it right to limit.

Sure. Could you just give us a little bit more scope on these operational challenges? How many facilities are being impacted? You have a rough sense of what it costs you in orders in the quarter?

I do, but it's probably not worth going out and talking about those. The fact is, not insignificant, particularly in IPD. Two of our larger plants our horses were impacted. These things happen. I wish we could all say no, these things never happen here. They do. Question is, we acknowledge it and we have got a plan to deal with it. Just look at IPD's results versus historical and you can draw your own conclusions as to what the opportunity is there, but it is not in insignificant.

Lastly on this variable comp headwind, sounds like it's going to be slight this year but in a typical year, what's the rough order of magnitude that you'd see in the P&L from resetting the variable comp?

It depends on how we perform relative to shareholder expectations. The reason, actually for this year, variable comp is a headwind relative to last year, but as you look out, it's all driven by our commitments to our shareholders. That's why we call it variable. We oftentimes work on cost containment and efficiencies to offset a lot of that, but if you think looking forward, it's a lot in terms of how we set our plans and a lot of that is aligned to how we're going to deliver to our shareholders. That's just the way business is overall. It's not a fixed cost in our business.

Right, right. Assuming were not planning for a dramatic rebound next year but we're just kind of executing the restructuring, is this a like a 10, 20 basis point headwind or is it like a point of head? Just rough order of magnitude.

Robert, we have got to set our plans. I think a lot of it is around the guidance that you see. The reason it's been not what we anticipated at the beginning of the year is part and parcel to the fact that you saw we dropped our guidance. That is an indication to you that we created a favorability relative to our initial expectations, because we made a commitment to our shareholders and have come up short of that. I think that's the best way to think of it. It is really going to be what you see is in the guidance next year.

Keep in mind, we've been dealing with this for many, many years. Inflation and everything like that is embedded in all businesses and the fact that we've been able to sustain margins and do things we do means we have a long history of dealing with this issue, delivering to our shareholders and addressing it. A lot of it's going to be how we set our plans and our guidance next year. That's three months away. Thanks, Robert.

Thank you

Joe Ritchie Goldman Sachs.

Thanks, good morning, guys, and congratulations, Mark.

Thanks, Joe.

Maybe starting on the retirement, Mark. Just curious, can you talk a little bit about the process you guys have in place for both internal and external candidates? I'm also really curious as you think about the 2017 plan, at this point, who's going to own it?

We all own it. I mean, I think this is important and one thing to remember, Joe, while I appreciate the compliments on the call, this Company is a lot bigger than any one individual, and specifically me. We have got a leadership team that is well intact one and two levels down that is driving the process. I don't go in my back office and come up with a plan for next year and deliver it to everybody. It is a very thorough bottom-up process that everybody owns. It's owned by the Company. To our comments earlier, our variable comp is very, very broad based.

To your former question around the process, worked very close with the Board. I have a lot of confidence in the process. It is going to be very detailed, very comprehensive, very thoughtful in terms of what I've seen and I think what's important is that I'm really confident with how they are approaching this thing and how they'll get this thing accomplished. I'm here to support for as long as they need. You should think about it in terms of very orderly, very thoughtful, very communicative, very, very comprehensive, certainly with a long-term view. My assessment of it is, I'll tell you, I have a lot of confidence in it, a lot of confidence in them in the process.

That's helpful. Mark. Maybe switching gears a little bit and talking about IPD for a second, so clearly it sounds like the restructuring is impacting orders and sales today. I guess the first question is, at what point does is stop? Is there -- you guys have timeframe in mind with Tom coming on board and now running that business where you feel good to you're going to a level environment where that's no longer occurring? The follow-on to that is really, you think that there is going to be maybe additional pricing pressure to try to re-acquire some orders, or how are you guys thinking about that?

On the first one, if you ask Tom, he wants it done yesterday, but in fairness it's going to probably take about two quarters to get these things up and running. On pricing pressure, no, because that is about taking care of your customer. If you think about a $1,500 pump, a $8,000 pump, a $10,000 pump, particularly a $15,000 one you order online, you're not worried about 5%, 10%. You're worried about getting a piece of equipment under the process conditions that you need spec to order as quickly as you can or getting the plant to respond to quickly.

I think the point is no, we actually anticipate pricing power because part of the issue is when you're not delivering, you don't have any pricing power and price correlates to ability to deliver on time. They may take your product with a longer lead time but their going to command price reductions for it. When you can deliver quickly, you can command a higher price. What I'd say is look over the next two quarters, have a lot of confidence in Tom. From the pricing side, we actually think it will really start to feed on itself terms of price and volume once we can execute because we have very good products. It's just we're having trouble getting them to our customers and making them -- making us easy for them to do business with. We have to fix that.

Got it. That makes sense. Thank you and congrats again.

Thanks.

Andrew Obin, Bank of America

Good morning.

Good morning.

Mark, congratulations on your retirement.

Thank you very much.

Just a question on capacity. I think I heard you saying that industry is going to have less capacity going to the next cycle. How do you weigh this against the fact that we are hearing that the Chinese players are getting a lot more active, particularly as Chinese EPCs are gaining market share, as well as the impact of additive manufacturing on the industry?

I think a couple things. In general, the traditional competitors are taking capacity out. You are right in terms of Chinese EPCs, but keep in mind our -- a lot of our capacity is designed to participate with those EPCs in some of their global efforts. Don't think about that these products, especially some of the more highly engineered, are going to necessarily just be picked up by local Chinese suppliers. Where we traditionally see Chinese competition are on the lower-end products. One of our key strategies is to develop capabilities like in the China power business, because we're well aware that not only of those Chinese EPCs going to serve their local markets, but the going to go to regions like Africa, and we want to go with them.

I'm trying to think of -- oh, your comment around additive manufacturing. Yes, in terms of some sub-manufacturing, a lot of our LPO SPO strategy is designed to have that internal capability and as part of the realignment, we're moving some of that manufacturing base manufacture out to our supply base as is our industry. You're right on, but I -- in terms of your comments, but don't view that as a negative. One is specifically a strategic area where we are addressing and another one is strategic/tactical in terms of we are approaching our realignment.

Just a follow-up question on the EMCs. What are you seeing in terms of people reopening contracts? Have we gone through the cycle already?

I mean, we haven't -- what we saw the cancellations in 2015 picked up quite a bit. We saw quite a few of those. That is significantly abated. In terms of cancellations and everything, there's been -- it's hasn't been of any great significance. There hasn't been a bow wave or anything like that in terms of these. These projects are fairly mature. They're moving along. Keep in mind we're pretty far along in the projects in terms of our product deliveries. You do see them from time to time. Part of the Latin American one was one that had a project that's been put on hold for quite a few years in terms of that inventory right now. I'm not saying it's not happening, but there isn't any significant change in the pace and cadence of these -- of those activities.

Terrific. Thank you very much.

You're welcome.

Nathan Jones, Stifel.

Good morning, everyone.

Good morning, Nathan.

Mark, I'm going to save my congratulations for February because you have still got five months of work to do.

Thanks, I'll appreciate it.

I'm going to go the M&A route here. When you bought SIHI at the start of 2014, you talked about that being an 18- to 24-month integration process, so you should be largely finished if not finished at the moment. What is the Company's appetite for further M&A at this point? Does that change at all with your impending retirement?

I think -- just remember, the Company's not about one individual. If a good opportunity comes up, I'm sure Management, we would all take a look at the opportunity. In fairness, new leadership may have a different point of view, especially as you get up the curve in terms of much more strategic type activities. I think if something is compelling as SIHI were to come along and it would make sense, I am certain Management and the Board would take a hard look at it. I just want to point that out.

We are continuing to move forward. We have things to do in our business and particularly realignment, which is an absolute priority. I'd go back to our capital allocation priorities and our priorities in our business. That's still first and foremost, which I can tell you can -- may impact our view in terms of when we look at in an external opportunity.

Does the bandwidth required for this realignment program going through the end of next year make it less likely that Flowserve would embark on a meaningful acquisition at this point?

I can just tell you that realignment is a priority and I expect it to remain a priority, Nathan. A lot of that is determined by the opportunity itself. Where is it? For an example, if we were having a discussion as a management team if something came up in our custom engineered business, you take a step back and say, wow, there's a lot going on there. Could we really integrate it? You'd have to risk adjust the opportunity. Flip side, and I'm not signaling anything, I'm just telling you how we think about it, is if you look at our valve business, you say, well, those are fairly discrete operations in terms of facilities. The ease of integration is going to be higher.

On a disciplined approach, you look at everything on a risk-adjusted basis. My point earlier is the highest return on every dollar we have is really in our realignment area right now. Hopefully that answers it because I don't know. It's a case study on the opportunity that comes up. If something came up that was very compelling, you have to evaluate that, but that's the way we think about it.

Okay, then I have one on capacity and price. You had probably your largest competitor in the engineered pump business talking about an expectation that demand and supply capacity would be -- would come at the balance towards the end of next year and an expectation that you wouldn't see any price improvement until at least then. Is that something that you'd concur with? Just any color you could give on how you think about it.

On our custom engineered, I think that's a fair statement is price is determined by amongst other things, capacity. I mean, you have to be able to engineer and design the product. You have to be able to deliver it on time. All those things being equal, it is going to be around capacity. I think in our other areas, particularly in IPD, it's going to be in our ability to execute. That's going to determine price more than anything.

All right, thanks very much. (Inaudible)

Talk to you soon.

Bhupender Bohra, Jefferies.

Mark, just question on the month of September here. Can you give us some color in terms of the end markets? We saw oil and gas, coal orders, the bookings actually grew 10%, but the non-oil and gas business has stayed weak here. If you can just (technical difficulty) in September and what are we seeing in the first few weeks of especially October here?

I think my comments were in general about the industry. We don't go into bookings month by month. In general, what you saw was typically you expect July and August to be somewhat slower, with -- you have Ramadan in the Middle East, you have vacations in Europe, vacations even in the United States. It tends to be a little bit slower in pick up. We just started out slower than originally anticipated in July and August but just didn't see the ramp up in September. My comment is more general around the quarter and I think you've heard that from our industry. I just wanted to provide you our color on it.

If you look at specific bookings, we did have an ebullator. Not huge, but an ebullator opportunity booking that came in. There's going to be a lot of moving parts but in general, what my commentary around the month of December -- September was, excuse me, was that we just didn't see the ramp-up that we normally saw in the month of September. Also as you think about September, there was a lot of uncertainty in the market then. You look back and you go, I guess that wasn't really a surprise, but we just didn't see the ramp up.

Okay, got it. Was that specific to a particular geographical region here?

No, it was more in general. I think this goes around. You think about all that's going on. The US has elections and that has a worldwide implication as people observe what is going on. I just think it was fairly broad based.

My next question was on the press release which you put out a day before your earnings was the collaboration with Honeywell on the Internet of Things here. Some of your competitors have talked about how they converting their assets to Internet of Things and making it more it making -- more them intelligent here going forward. They have even talked about sales funnels because of this application. I don't know if you want to give a broad perspective on where Flowserve is as you're collaborating with Honeywell and I believe HPE on and how that thing actually goes over the next two years or maybe even (inaudible).

Sure. This is important, because in this in these capabilities, these smart plants, the product matters. That's where you embed the sensors. That's where the basic algorithms come from in terms of the know how or the process conditions. We're right in the middle that. I've talked about that on earlier calls. It's where we're spending some of our time is making sure that our equipment can, because it's critical to the process, our equipment has that capability because we think over time, customers are going to increasingly value that. What you saw with our relationship Honeywell, you've seen them with other providers before, is part of the value chain in terms of how we deliver that capability to the customers.

Keep in mind, a lot of the predictive algorithms and everything come from the product manufacturer because they know the product, they know the process conditions, they know the hydraulics. They're the ones that can actually make the machine smart. We think it's a great opportunity going forward. My view us it's not going to occur overnight, but it's certainly is going to start to penetrate the market and when I think about how highly engineered our equipment is, the know-how that goes into it, our ability to embed sensors, the ability to ubiquitously transmit that information, I think it's going to be a real opportunity.

Thanks a lot.

You're welcome

Joe Giordano, Cowen.

Thanks for taking my questions. I wanted to talk about capacity quickly again. There's no question that everyone is taking footprint out, but you get the sense talking to some people that through things like lean and automation that the actual quantity of items that are able to be produced isn't really changing a whole lot relative to the amount of square footage being taking out of plants. Can you maybe comment on that a bit? Is there a need for larger scale consolidation within the industry to achieve more of a balance?

That's actually a fair statement is I think that what you've commented on is we will have less footprint, 30% less facilities and I'm confident that we would be able to execute on back -- any of the backlogs we've had in the last 5 to 10 years for the exact reason you've talked about. That is, we had a lot of under absorption in the most recent peak in our cycle in 2014, so we'll eliminate a lot of that. Then the comment earlier around sub-manufacturing, our LPO SPO, the ability to move work, our focus on more highly engineered products. What that does is that obviously gives you better absorption in the business. I think that as I look at our business specifically in terms of what we've done over the last particularly in the last five years, we will have less square feet and equal or more manufacturing capability and throughput capability in our business.

In terms of industry consolidation, yes and no. All manufacturing is not equal. You need to keep that in mind is that some of our facilities have the ability to manufacture certain or specific products. When I think about our CE acquisition, that wasn't -- there was very little consolidation in that it was more around adding product and product capabilities to our portfolio.

Now, you can move some of their products into some of our facilities, which we've done, and by the way, we moved some of our products into one of their facilities. There is the opportunity to do that but I'd caution you not to think of our capacity as ubiquitous, and it's just a matter of square footage. You've got to have the know-how, the capabilities, the right machining, the right experience in those locations. Clearly, though, our efforts are going to make us much more efficient.

I would just add to what Mark says on the capacity side, that's one aspect of the realignment. The other aspect is a strategic repositioning of our products and people around the world, similar to the previous comment that came up in terms of the EPCs going in different locations. A lot of the jobs going forward are requiring more local content and that is one of the aspects of the realignment is the strategic repositioning of our assets.

That's a good point. In many countries, you must be present to win.

Is this -- while that's all obviously very positive for Flowserve, if everyone else is doing a similar thing, is this inherently bad for the industry where if the markets don't materially accelerate and get back to OE levels that would justify this level of volumetric capacity, has nothing really changed from an overall industry perspective?

No. Look, the industry has taken enough capacity out. Keep in mind, our industry was stretched for capacity in 2007 and 2008, so it's not like there's was a bunch of extra capacity. The industry is taking capacity out. We're fairly aggressive on it. I can't comment, generally, specifically on some of our competitors, but generally they're taken the capacity out. The industry knows how to right size itself. It's had plenty of time to do that. I'm confident that the industry, it's not could be perfect on capacity. If anything, there will be a little extra.

Just keep in mind, we are one of the ones that are more capable about moving products around our facilities around the world. Just because 80% of your plants are full, doesn't mean that 20% of them won't be under absorbed even in good times. I think it's probably to remember to say not all capacity is equal. Our industry is responding by taking capacity out, particularly players like Flowserve that tend to be on the higher-end products. There's -- they've rationalized that capacity. I don't think there's going to be a big capacity overhang where we go into the next uptick.

Thank you.

You're welcome.

John Walsh, Vertical Research.

Hi and thank you for taking my question.

You're welcome

I have a clarification and a question. I think thank you for the color on 2017 and I apologize if I missed it, but did you actually say whether or not you could grow earnings next year?

Did not. I said we'd provide guidance in three months.

Okay. Fair enough. As we think about cash flow into next year, obviously this year you have a headwind from the realignment cash. I think there's still a modest headwind based on your guidance for cash from restructuring cash, but how about some of the other lines, pension, CapEx, cash interest. How should we think about those into next year?

Well our pension cash outflows have been fairly steady for the last couple years and as Karen mentioned in her comments, we are fully funded. I don't want to, again, get ahead of our guidance, but I would say the biggest consumer of our cash looking into next year is going to be following through on our realignment initiatives. It's pretty much as simple as that. Then as -- in our industry as we deliver a lot of these large projects, that does tend to cause your balance sheet to liquidate slightly, especially the large ones. We will give the guidance in January, but I think if you look at the just generally trends that we talked about, I would focus the most on our realignment cash in terms of making your assumptions.

Okay. Appreciate the color. Thank you

You're welcome

Thanks.

Scott Graham, BMO Capital Markets.

Hi. These are two quick ones. Mark, there's been a lot said about the aftermarket, the turnarounds, the lack of them, the push backs and what have you, yet here you are with an aftermarket bookings number of about down two. It essentially shows stabilization. What are you trying to say about aftermarket with that type of number which supports stabilization? Are you concerned about it going forward or is it something else?

No, I'm not concerned about it. I will tell you we have to earn that business every day. No, I haven't expressed a concern. We've been pleased with the stability we've seen in the tough environment we've been in.

Got you. Last one is the corporate expense. Is that a number we can see repeat going forward, or is that maybe just really tightening your belts in the last two quarters of the year?

Well, we are always going to continue to tighten our belt, Scott, and if you look at corporate expense over the last seven years, we've managed that very tightly. You should expect us to continue to do that.

Very good. Thanks.

You're welcome.

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