Flowserve Corporation (FLS) Q3 2014 Earnings Report, Transcript and Summary

Welcome to the Flowserve Q3 2014 Earnings Conference Call. My name is Christine, and I'll be your operator for today's call. [Operator Instructions] I will now turn the call over to Mr. Jay Roueche, Vice President, Treasurer, Investor Relations. You may begin.

Thank you, operator, and good morning, everyone. We appreciate your participation today as we discuss Flowserve Corporation's financial results for the third quarter of 2014, which we announced yesterday afternoon in our press release and Form 10-Q filing. Joining me on the call this morning are Mark Blinn, Flowserve's President and Chief Executive Officer; Tom Pajonas, Executive Vice President and Chief Operating Officer; and Mike Taff, Senior Vice President and Chief Financial Officer. Following our prepared comments, we will open the call to your questions, and instructions will be given at that time. Before turning the call over to Mark, let me remind you that this event is being webcast and a slide presentation is available. An audio replay will also be accessible approximately 2 hours following the conclusion of this live call. Please note that this call and the associated earnings materials contain forward-looking statements that are based upon forecasts, expectations and other information available to management as of October 24, 2014. These statements involve numerous risks and uncertainties, including many that are beyond the company's control. And except to the extent required by applicable law, Flowserve undertakes no obligation and disclaims any duty to update any of today's forward-looking statements. We encourage you to fully review our Safe Harbor disclosures contained in yesterday's press release, slide presentation and our Form 10-Q, as well as our other filings with the Securities and Exchange Commission, for additional information. All of these documents, including the live webcast and replay are accessible on our website at www.flowserve.com, in the Investor Relations section. I would now like to turn the call over to Mark Blinn, Flowserve's President and Chief Executive Officer, for his prepared comments.

Thank you, Jay and good morning everyone. Overall, I'm pleased with the results we delivered this quarter and our earnings of $0.93 per share. Our employees remained focused on the customer, the products and services we deliver, and their dedication and commitment drove improved margins and higher earnings year-over-year, even as revenues were relatively flat on a constant currency basis. A number of factors impacted the current macroenvironment in the third quarter increasing global uncertainty. While our execution has continued to improve, many of our customers are being deliberate when accepting shipment, as some of the products are not on the critical path to project completion. This impacted revenues in the third quarter by keeping the finished product in our facilities and inventory, and represents a continuation of what we saw on the second quarter. While this is a revenue timing issue for us, it may persist as we begin the project cycle. Additionally, revenues for the third quarter were also impacted by a stronger dollar. Despite less than expected revenues, I am pleased we’ve delivered gross margin and EPS improvement this quarter, which demonstrates the benefit of our operational improvements, aftermarket franchise, and the potential for cost leverage with growth. A key highlight supporting our positive outlook was another quarter of solid bookings, including an 8% increase in aftermarket bookings. Additionally, our year-to-date backlog is up 10.4%, or 14% on a constant currency basis, with the year-to-date book-to-bill of 1.1 times. Another key strength remains Flowserve’s diverse market and regional exposures. We again realized strong activity levels in North America, particularly within oil and gas, which more than offset challenges in our power markets and certain emerging regions. While emerging regions can be volatile as we’ve recently experienced in parts of Latin America, Asia, Russia, and the Middle East, they remain an important and profitable component of our strategic platform, and we will continue to pursue disciplined growth in these parts of the world. Long term, we expect continued regional investment in new infrastructure and increased aftermarket services, which is why we remain committed to these markets. In North America, oil and gas and chemical investment continued in our mid and downstream markets, even as customers pulled back from certain upstream investments. Although oil prices have been declining of late, as many of you are aware, Flowserve’s oil and gas focus on a global basis is primarily away from the wellhead and rather in mid and downstream infrastructure. In these markets, short-term oil price volatility historically has had less of an impact as lower feedstock costs can benefit refineries and other process infrastructure. The associated increased hydrocarbon production also requires more midstream investment, which is particularly true in North America. We don't claim to be totally immune as oil and gas CapEx spend could be impacted at some price, but we do believe Flowserve is well-positioned in the current environment. Looking at the global power market, our bookings in this industry declined 11% year-to-date as it continues to be inconsistent and lumpy with regulatory uncertainty. But we continue to expect that the world will require additional generation capacity over the long term, and our capabilities will serve that market well. Europe remains an important overall geography for us returning to stability over the last year, and the region produced bookings growth of over 10% year-to-date. We continue to monitor the economic indicators in this region, but recognize a sizable installed base exist, and that our customers intend to keep those assets performing. For the year, Latin America has been a challenge compared to our expectations with year-to-date bookings down about 3.6%. During the third quarter, some Latin American customers continued to invest despite political and financial headwinds, which supported 5.7% bookings growth for the region. Over the long term, we see Mexico's decision to open their markets to foreign investment as a positive development and perhaps Venezuela’s foreign financial agreements will also support further investment in the region, but we continue to actively monitor and respond to the rapidly changing developments in Latin America. Asia remained our most challenging region with bookings down roughly 8% through the year as customers reevaluate investments due to slowing growth in the region, and the impact of North American shale related to investments versus their local alternatives. Long term, Asia still represents an opportunity for Flowserve as we expand our overall presence to capture additional market share. From an operating perspective, our performance was strong demonstrated by the third consecutive quarter of 35% plus gross margins. This consistent execution is a result of our strategic initiatives that we began several years ago, including One Flowserve, project discipline, focusing on the customer, and tight cost control which ultimately delivers profitable growth in improving shareholder value. Our progress in these areas has been substantial, and we believe this culture is becoming embedded and sustainable across our platforms. While we’re about halfway through this journey and continuous improvement efforts will never end, we are now increasing our focus on growth including accelerated organic investments in products, markets, and regions that deliver appropriate returns, strategic acquisitions, and at the same time we’re pursuing initiatives to improve the returns from our asset base through increased manufacturing optimization, capacity alignment, and improved cost absorption. As we look at the fourth quarter and into 2015 and beyond, I'm encouraged by our profitable growth prospects driven by our demonstrated level of operational excellence in growing backlog and further the level of bids and proposal requests from our customers supporting the expected increase in activity in our core energy markets. In summary, Flowserve is performing well. We entered 2014 encouraged by the signs of global growth, but near-term uncertainty has cropped up during the last few months. However as we look forward we're encouraged in our ability to deliver growth and continue to believe the long-term secular trends remain very much intact. We have a stable operating platform and intend to deliver organic growth as well as opportunistically pursuing M&A. We have capacity in our facilities for significant growth and opportunities for realignment. And finally, we will not take our eye off the ball as we have initiatives for additional operational improvements. Together, we expect this formula will deliver meaningful long-term value to Flowserve’s shareholders. So with that overview, I will turn the call over to Tom.

Thanks, Mark and good morning everyone. I am also very proud of the progress we've made in our long-term strategies of operational excellence and customer focus, which are becoming sustainable improvements in our culture. Our employees have embraced these initiatives over the last few years, and the results they have driven are significant. At roughly halfway through the process, we envisioned several years ago, we remain encouraged by the additional identified opportunities to further improve our performance and better serve our customers. The company has demonstrated improvements in all key measures of operating performance, including margin expansion, on-time delivery, past due backlog and cost of poor quality. This progress provides confidence that our strategies, customer focus and prioritized investments in the areas such as quality and project management have the Flowserve engine performing at a high level and well-positioned for expected growth, bet it organic or through acquisition. We will continue to pursue additional opportunities to further align our global asset base to drive even higher efficiency, utilization and greater return. Strong margin performance we have delivered highlights our ability to generate earnings despite a relatively flat top line environment. IPD's notable improvement included a 220 and 250 basis point increase in gross margin and operating margin respectively, excluding the impact of a discrete non-cash charge. While macro uncertainty may challenge our markets, we continue to expect growth and intend to leverage it through our stronger platform. This quarter’s gross margin improvement, which included strong aftermarket shipments and the benefit of our consistent disciplined focus on building a quality backlog, generated a 30 basis point improvement in operating margins and continued tight SG&A cost management. Our bookings highlight the quarter and indicate expected growth to come. Consolidated bookings increased 5% on a constant currency basis, led by an 8.1% increase in aftermarket bookings and continued solid run rate OE activity even as most larger projects remained on the horizon. Last quarter’s strong original equipment bookings in EPD and IPD turned relatively flat this quarter for both segments. This simply reflects the lumpiness in orders we often experience. As expected, FCD’s third quarter year-over-year bookings improved following the second quarter's year-over-year decline, increasing 5% driven primarily by strengthening oil and gas market. Excluding the divested Naval business from a compared period, FCD’s bookings improved 8%. Turning to our end markets. Oil and gas was the primary driver of our bookings increase with third quarter growth over 18%. The recent decline in oil prices and the forecasted reduction in near-term global growth rates have added some uncertainty to the near-term investment from certain customers. However we believe upstream investment is at greater risk for scrutiny within this context. And Flowserve’s exposure is more mid and downstream focus. We continue to expect significant North America activity driven by pipeline construction, refinery upgrades, gas processing, and gas to liquid plants. We also expect new refining investments to occur in the Middle East, Latin America and Asia, including clean fuel initiatives. However some of the investments may challenge the current European refinery market. Europe is, however, expected to increase its diesel production. Brazil is proceeding with further FPSO development. Longer-term Mexico should present increased opportunities following the recent policy reform intended to increase production levels. From an oil and gas aftermarket standpoint, maintenance activity in the Gulf Coast continued the first half year trend, with increased bookings growth compared to levels we saw in recent years. In the chemical market, bookings decreased 1.7% in the third quarter following a strong first half of the year. New capacity projects in North America continued to advance, including ethylene, and ethylene-derivative projects driven by the low feedstock costs in the United States. While the majority of new chemical investment is still expected to occur in developing regions, the chemical production capacity in the US is forecast to increase 30% in the next decade. In the Middle East, downstream expansion efforts continue. Meanwhile Asia and Latin America are reassessing their chemical development plans, based on slower economic growth and competing opportunities in the US. While some European capacity is expected to [cover] -- utilize US ethane. The power market continues to be our most challenged served industry, given the current slower growth environment and the ongoing regulatory uncertainty. Longer-term we still believe that new generation is required. China, India and Russia are indicating they would pursue fossil-based projects and parts of Europe are even investing in fossil based projects as certain countries retreat from nuclear power. The Middle East also sees increased needs, both in conventional and solar power. North America and Europe, however, remain slower in aggregate due largely to conservation, the lack of a consistent energy policy and modest energy demand drivers. The low price of natural gas and recently announced CO2 reduction guidelines, however, should continue to drive the US combined cycle market subject to adequate pipeline capacity. Nuclear power remains in transition but China, Russia and South Korea see continued development and there are discussions of new capacity in some regions of Europe. Following its new safety standards, Japan is closer to restarting a portion of its nuclear capacity which has been idle since 2011. Finally, natural gas combined cycle plants remain a global opportunity. Wrapping up, we continue to expect significant investments in our key energy markets even as we’ve seen increased macroeconomic uncertainty and forecast for slower growth to further impact the timing of project awards. However the level of bids and proposals at the current time is encouraging. Whatever the ultimate timing of these investments, I'm confident that we have made the progress necessary over the last few years that would differentiate Flowserve through superior execution capabilities, increased capacity and flexibility to adjust our customers’ requirements and changing market conditions. With that overview, let me turn it over to Mike Taff.

Thank you, Tom and good morning everyone. With Mark and Tom covering our operations and business outlook, I will discuss our financial results in greater detail. Our strong operating performance delivered a $0.03% increase to EPS in the quarter to $0.93 per share in spite of a $25 million reported revenue decline. Adjusting for currency effects and the impact of the sale of Naval in the first quarter, revenues were essentially flat, similar to the second quarter. We continued to experience elevated customer-directed shipment delays during the third quarter which limited our ability to recognize additional revenues from products that were prepared to ship. As many of you are aware, the US dollar strengthened sharply versus the euro and other currencies in September. At this level it would present a translation headwind to our reported fourth quarter revenues. Gross margins were again impressive this quarter at 35% and demonstrated our ongoing operational excellence, the improved quality of our backlog and the mix benefit of strong aftermarket shipments. Year-to-date aftermarket bookings were up 7.2% through September and we have now achieved our fourth consecutive quarter of over $500 million in aftermarket bookings. SG&A expense declined modestly in the quarter and is down year to date as focused cost control remains a priority. However we continue to make important investments in SG&A at the same time in areas such as R&D, quality and project management resources to name a few. With revenue increases we expect to effectively leverage these costs and therefore we remain committed to our long-term goal of SG&A as a percentage of sales in the 18% range. Operating margins increased again this quarter with a 30 basis point improvement to 16%. This level is near the high-end of our previously announced 3-year margin improvement guidance of 15.2% to 16.2% by the end of this year. Additionally IPD continued its steady progress towards its targeted 14% to 15% range by the end of next year even as it was impacted by $3.5 million non-cash discrete charge this quarter. Below the operating line, other income came in at $5.6 million, up almost $4 million from a year ago primarily due to revaluation of net US dollar and US dollar pegged balances around the world. Our tax rate for the quarter was roughly 29%, slightly better than our guidance rate of approximately 30%, driven by higher than expected foreign income. Turning to cash flows. We generated $137 million from our operations during the third quarter, which increased our year-to-date operating cash flow improvement to $17 million compared to last year. Consistent with our normal seasonality, we expect a significant portion of our cash flow to be generated in the fourth quarter. Our long-term goal remains to consistently generate annual free cash flow near the net income level. During the quarter share repurchases and dividends used about $57 million of cash as we continued to return capital to our shareholders. Other spending included capital expenditures of about $30 million and we repaid $10 million of term debt. Working capital remains a key area focus but progress is slower than desired. Certain Latin America customers continue to delay payments. Their balances are not in dispute but this persistent practice has negatively impacted our DSO. We're monitoring the situation and taking a number of actions but significant improvement will continue to take time and effort. Inventory balances increased from December 31 due in large part to our growing backlog but are down compared to a year ago. As such we made modest progress in the quarter increasing turns to 2.8 times from 2.7 times last year. This improvement reflects our focus on on-time delivery and achieving our fourth consecutive quarter with past-due backlog below 5%. Moving to our outlook. We expect another solid fourth quarter, reflecting our normal seasonality. As is typical at this time of year we have narrowed our earnings guidance to reflect our year-to-date results. For 2014 we’ve tightened the EPS target range to $3.65 to $3.85 per share, still within the original range. This range now suggests a 7% to 13% year-over-year EPS increase. From a revenue perspective we now expect that line item to be essentially flat on a constant currency basis for the year due in large part to the recent challenges in predicting the timing of revenue recognition primarily the result of customer-driven delays. The good news looking ahead is our backlog has increased over 10% year-to-date and top line opportunities are still there but predicting the exact timing has shifted somewhat beyond our sole control. Turning to our capital priorities. As mentioned earlier we continue to return value to our shareholders and remain committed to our disciplined approach to capital deployment which includes organic and inorganic opportunities. With our operating platform performing so well, we feel opportunistic growth investments will provide solid returns for shareholders. We also continue to invest in our core existing business, furthering our capabilities in emerging regions and supporting our aftermarket Strategies to deliver profitable growth. One such example is a new initiative recently approved by our board to further expand and consolidate our valve activities in China. In summary, the business has performed exceptionally well during this pause in topline growth. We've successfully delivered solid earnings, increased our backlog in a disciplined manner and positioned the company to pursue organic and inorganic growth opportunities. With that, I'll turn the call over to Jay.

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

(Operator Instructions) And our first question is from Charlie Brady of BMO Capital.

Hey Mark, could we just get on a little more detail on the shipments? Can you maybe give some more granularity on the magnitude in Q4 and kind of the timing of the delays you're seeing, and are you seeing an acceleration in the duration of the timing on those delays?

Yeah, I mean I think generally the way to look at it is as we brought our past-due backlog down over the last couple of years and improved execution, our projects are no longer on the critical path and often times customer isn’t ready for it. That part of the project, they certainly don't want the piece of equipment sitting outside in the elements for a period of time. So that’s the environment we’re in right now, and so what you see is it can push from the end of the month, the end of the quarter into the next month. We saw that in the second quarter, and I think in the second quarter it was roughly about 70 million that we anticipated or roughly about $100 million this quarter, I think it's important to note, Charlie, that during these times, this can in a sense persist, especially for the right reason in that we are executing well and the equipment is available when it should be. This can be the way these projects go. These are long cycle projects that take time, we are a piece of it. We are not necessarily the long lead time piece of the equipment as you can imagine, but in a complex pump, I think has to be ready, the engineers have to be ready. There is a lot of factors -- this kind of goes back to why we’re not a quarter to quarter business, it takes years to build these facilities. So, I think just the important thing to keep in mind is these things aren’t going out of backlog, these things are not getting canceled because the project is well on its way. But since we are not on the critical path, which is good news for us, these things can slip for that period of time, and that’s in a sense what we've seen really during the course of this year.

Is that slip – can you – are you seeing most of these 30-day slippages or 90 day slippages or is it?

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

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

Usually, we have a year-end disclosure, Charlie, and I think on the engineered equipment about 85% -- depends on the lead times and the environment we’re in, but let's say 80% to 90% of that will typically ship in the subsequent year or be counted in the percentage of completion, keep in mind on a long lead time project that sizable, you may not -- what you'll be seeing is percentage of completion come through as we build the cost associated with that project. But in fact, some of the equipment can take 40, 50 weeks, and those are the planned delivery times. Go back to where we were in '08 - ’09, that was an environment where we were quoting 70 weeks the market was at that point. But typically these -- a lot of stuff goes within the year.

Thank you. Our next question is from Michael Halloran of Robert Baird.

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

But I think what will need to drive this I think more steady-state and more predictable from our standpoint is a little less volatility around the world, because on the margin, that will cause folks to delay a decision. The other thing that will drive these things coming to market quicker is there's a big spike in commodity costs or underlying cost like you saw in 2007, 2008, otherwise what you'll see is -- absent those, you'll see steady as she goes in terms of how they allocate resources. But those things can impact that on the margin, so if you see all of a sudden economy starting to heat up, they will pull these things to market for fear that what happened a number of years ago where the budgets on these go up quickly, I don't see a situation like we saw on ‘09 where the market is going to go into price discovery mode because there's been a quick rundown in all commodity costs. You remember oil, I think went down to 40 bucks a barrel at that point in time. So, a shock to the system one way or the other can impact it. The other thing is going to be I would say country specific. So whatever the political environment is in that point in time, what you’ve seen in Brazil is there was a lot of investment and then the new president came in. They kind of put the foot on the brakes. Now there may be a pro business leader that becomes in at that point in time that may drive more spend. The fact is they do need to monetize those reserves, flipside is what you saw on Mexico as they realized they needed to get external investment to drive that more and more, and we've seen a pickup there. In Russia, what you’ve seen is some political turmoil, and you're well aware of what’s occurred. So Mike, it is going to be country specific, but I think the point in terms of the reason we look at these secular spends out there is a lot of these economies are highly dependent on the price on oil and oil production, and price has a component to that as you're seeing in the market right now, but still production is going to be key to these markets. Independent oil companies look a little differently. I think what you've seen is they’ve scaled-back a lot on their upstream investment and returned to shareholders, right, the sovereign companies, they are shareholders with the government, those are the kind of things that can impact decisions. So, it's different and absent – Mike, absent some broad shock in the system that we saw on ‘09 or a broad impact that we saw on ’07, ’08 with commodity prices coming up.

And then second one is when you look at the quoting activity out there and you look at the stuff that's in your feet, how much visibility do you have into your success in those pieces? And I'm assuming that well before an order is actually finalized that you’ve got a good sense for what Flowserve’s odds are on that particular order, so maybe just talk about the visibility or maybe talk about the win rate you're seeing and things that haven't yet been booked and are coming to the pipelines?

We do monitor all those metrics carefully, and a lot of it in terms of your ability to predict success are the specifications – do you have the capabilities, do you have superior capabilities relative to maybe some of the other competition? Can you support the equipment afterwards over a period of time, do you have a good installed base there? But I can tell you, Mike, on a lot of these large projects, it’s still the environment at the end of the day where it can come down to price. So we can even be moving to the close on some of these things, and if somebody comes in, a competitor comes in and drops the price, that can certainly impact it. So I don't want to suggest that we know for certain as we go into these projects, because it’s still a competitive market. That is the way the engineering contracting firms want it. Having said that, the other things that I mentioned certainly give us visibility. We also think that our ability to execute and respond, that’s so critical. If providing a quality product on time is really at the end of the day some of the cheapest equipment that a customer can buy, so that’s -- but we do monitor it. I can tell you there is -- we look at win rates, we look at bid activity. We look at our customer relationships, and I think what we’re trying to tell you what has been encouraging is improvement in the operating platform and that gives us I think better access to our customers and a lot more flexibility in terms of how we approach these markets.

Thank you. Our next question is from Andrew Kaplowitz of Barclays.

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

Well we like the absolute amount to your point and if you look over five years, I think we’ve grown this business from about $1.6 billion to now approaching $2.1 billion, and that's through a downturn in global economies, competitive environments, uncertainty, we’ve seen oil dip down. We've seen refinery capacity become available. We've seen all kinds of things, regulation – and the point is it's been a steady growth over that period of time. You know as well as I do over the long term is – as we hope we continue to grow this business, we’re going to be lapping larger numbers. But the fact is we will also be putting more resources in. Some of the things that we’ve looked at in terms of growing our business or even investing more in our aftermarket capabilities, so I don't want to guide on absolute basis what our percentage growth rate will be but rather point to the fact that we’ve steadily grown this business. And we still think we have a lot of opportunity to capture installed base which we're not taking care of, also the ability to put more quick response centers, yield tax, service tax at or near all of our customers, to buildout the infrastructure in some of the emerging parts of the world where we really don't have the type of presence that we do in parts of Europe and the Gulf Coast region. That's what encourages us in terms of aftermarket growth.

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

Well it really does come down to the question earlier -- most of the backlog that we have in any period of time will execute within a 12 month period. So if at any compared period you see increased backlog, that's one of your best indicators in terms of just the base level amount of backlog what can contribute to revenue growth. The other thing to take a look at is what are the trends in the book-to-bill and year-over-year bookings growth which you've seen good growth in book to bill year-to-date. Obviously that feeds into increased backlog but if that's the trend over rolling period what that indicates you is that it can contribute to increasing backlog at various points of time. I think the third one is looking at growth of the aftermarket business. High margin, high profit business, quick turn, that will tend to turn over a shorter period of time. That's what will drive growth.

Thank you. Our next question is from Scott Graham of Jefferies.

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

No, those are various things, that could be some shorter thing in some projects. Those are typically projects.

Typically projects, so not a short cycle?

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

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

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

I guess what – some of the questions were about an appropriately -- so is that -- last quarter, kind of seemed like 40 million, this quarter more like 80, we’re trying to connect the dots therein and see maybe why your tone is maybe not a little bit more pessimistic because you still seem pretty upbeat on the large process, project cycle?

Well, let me tell you first and foremost why I'm encouraged and Scott, you’ve followed us and I've known you for 10 years. I mean the operating platform that we have right now as I said has improved so much that gives us a tremendous amount of optionality in terms of penetrating additional customers, growing our business, all types of things that we can do. And I think that's more of the optimism you’re hearing than anything else. And also we do look at current bidding activity. To the question earlier, I wish we win every bid that we gave, but we don't but we monitor the bidding activity and it's been good which is encouraging. These things have been on the drawing board for a period of time and we knew they were going to come to market and we do certainly see the bidding activity that’s out there. I think that's what's been encouraging. If we look back over this year, the one thing that we obviously wish we’d have been better would have been on the revenue side and we’ve certainly seen - we had a divestiture, the impact of some currency which we can control but in this environment we see these things and move on but they don't go away, they do remain in backlog. So I think in generally we’re encouraged because I think or I know that a lot of the things that we have in our control we've improved on or have the opportunity to improve on. These things – these microenvironments around the world and foreign currency and things we can control but they do provide opportunities for us. Keep in mind as the dollar strengthened some of our non-US sites certainly become more competitive globally.

Thank you. Our next question is from Stephen Fisher of UBS.

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

No. When these things are this far along, there's no benefit in slowing things down. Time is money on these projects and it could be the rest of the supply base but I think moreover no project goes to the exact period of time that it's expected to – or often times they don't. And I think the more important thing from our perspective is if you’ve monitored our past-due backlog it's come down significantly. What we've done is taking our equipment off the critical path. So to your point they may be dealing with another supplier who may be late or not that is a contingency to when they put our equipment but in general when there is -- by the time our equipment is ready to be delivered there's been a substantial amount of investment in the project and there is no benefit in letting that project linger for extended periods of time to anybody.

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

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

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

Well, in general -- what we don't want to do is -- we have guidance out there to the end of the year and we certainly don't want to spike the ball before the end of the game. But as you can see we've made very good progress. We do have the opportunity for margin improvement going forward. I think that'll obviously be something we talk about going forward as we look at -- what I would say is the next steps in this business and I think what we tried to communicate is we spent the last three years heads down focused on improving our operations, we're not done but what we've done is we brought it to the point now where we can start dialing up our organic growth opportunities and investing for growth and taking advantage of some opportunities we have to even drive more efficiency in our manufacturing platform. All of those things as you can see growth we’re going to get leverage in our business, driving efficiency will contribute to the gross margin line and the operating margin line. We will get cost leverage in our business, growing our aftermarket business and even doubling down on that will help with the margins as well. So what I'm trying to do is piece together something that we will continue to talk about as we look forward, where we think we can drive growth and margin opportunity in our business. But we still want to get where we told you we were going to be. I mean IPD's not there yet, it's made great progress, I think all through a little sceptical at points in time but look at the progress they've made. And we’re within the 150 to 250 actually kind of towards the high end but as I said we’ve got one quarter to go to the end of the year. And we feel pretty good about things.

Thank you. Our next question is from Chase Jacobson of William Blair

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

Actually that is exactly the message we wanted to make sure you didn't take away from this. No, it's not that we have any concerns over growth. Back to my comments originally, when you're in a strong up cycle, you’re doing everything you can to deliver your customers. When things turn down as they did in ’09 and ‘10 you’re trying to drive costs out but it's fairly inefficient. And as you're trying to improve your business the last thing you want to do is start consolidating and rationalizing capacity because that will impact your execution. It’s – you don't want to do those things simultaneously unless you’re in a big post-acquisition mode. So what we see with a more stable platform is the opportunity especially since we've added a lot in the emerging parts of the world, they start to drive more efficiency and some of our capacity around the world. That's what a smooth operating platform offers to us. We have plenty of capacity to deal with growth and in fact some of those activities ultimately hold capacity on an execution basis neutral or increase it. So what you're seeing is a level of confidence in our operating platform which we believe gives us the opportunity to do some things that will really drive long-term value in our business.

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

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

No, Chase, I would say, not changing anything. I think we’ve reached some different phases, obviously we went through – it’s kind of three phase approach as I have looked at it, kind of an assessment phase, and then we’ve developed tools and now we are in the implementation phase. And we’re right in the middle of that implementation phase which will take over the next 12 to 18 months to get it fully implemented. So we’re still 18, 24 months away from fully achieving those goals and getting it spread throughout the whole organization. But I do think we've reached the important phase of implementing the new tools and process and procedures. It’s just going to take time to get it implemented throughout the whole organization. We’ve got 220 plus occasions that generate revenues and where we get to manage inventory and drive better collections. So I think the tools we’ve created as well as the process and procedures will serve us well down the road.

Thank you. Our next question is from Andrew Obin of Merrill Lynch.

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

I think these things kind of ebb and flow by various customers. The most important thing is you just determine creditworthiness and some of them tend to pay slower, I can tell you the sovereign state amenities tend to be slower than the independents. And so if there's mix shift, part of going to the emerging parts of the world is they do tend to play slower, and then there could be anything, short-term with those customers that can cause some of the drag things out. So what I will tell you is I think we will always have some element of this overall in our business in terms of dealing with some sovereigns that will pay when they're ready to. And I think the important thing too is certainly we price that into, I mean we’ve got to understand what those payment terms and work hard to negotiate better terms and conditions which include payment terms but also understanding when that comes in and make sure that’s priced into our bids.

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

Can I step back and ask a bigger picture question? Every day I am getting calls from investors telling us that the energy cycle is over, oil is going to $70, positive correlation between oil and downstream spend -- not much I can tell them because we are not really going to find out as to what's going to happen for the next six to nine months with these big schedules. But what I want to ask you guys, what really stood out about your business model back during the downturn is the resiliency of the business model and lack of cyclicality for what is perceived to be a very cyclical business. And the pushback I get is well this was the time when Flowserve was really changing its business model, and if something similar happens today, the business model is just not going to be as resilient in terms of earning sustainability. What do you guys say about that sort of the performance of the business model during a shock period as the company stands today?

Well, I will just say that I mean the business model worked in a shock that’s far more than anybody is considering at this point in time. Going to the price of oil, let me just take a step back. I mean remember, there was a bigger shock a number years ago and investment continued, why – I mean if you look at it right now -- right now where you see the price of oil, it's more of a supply issue than it is a demand issue. Nobody's saying that there is permanent demand destruction that the Chinese are no longer buying more cars; urbanizing, there is no need for hydrocarbons anymore. What you see right now is more of the supply issue. So when you look on the upstream side, you can see where people are moderating their investments for a period of time, not 30 years because there is no perception that demand is going to go away. But over the short-term they may moderate it. Now that will typically be as I described earlier the independent oil companies. When you look at the sovereigns, when you look at the government-owned entities as I mentioned earlier, production is correlated to their economies, some very highly correlated, somewhat notably correlated. You start moving downstream, if you think about the key around suppliers I mentioned earlier, transportation is not there, particularly in the United States. Look at all the production that we’ve had at the well site and yet we can't get it to market. We need more transportation and storage which will support more midstream investment. And then if you go further on the downstream side, there's a number of factors there. None of us buy a barrel of oil and put it in our car, or put it in an airplane. So the fact is as long as there's commercial demand out there, you’re going to need downstream processing capabilities to serve those markets, because the real value in a barrel of oil is the ability to turn it into something that somebody is going to use. The other thing to think about is people could have called the ball on natural gas a couple years ago down at $2 to $3 and saying, boy, that's going to go away. Well what was the knock-on effect there? The knock-on effect was they were starting to use that as a low-cost feedstock and driving to the processing site. So processing is really going to be driven by the downstream, by demand which again nobody's indicating is going away. Demand for bearing products, demand also for bearing cost of feedstocks and availability of feedstocks. Also there's an independence element to that. I am reasonably confident that the United States will never shut down all the refining capacity because then they'd be at the mercy of some other country. So if you think about it, I don’t think anybody's indicated that the 10, 20, 30 year demand for energy in the sector spend is going away but on the margin maybe some upstream investment might be moderated some, we still think that's a good opportunity long-term. But it creates other opportunities out there and a great example is going back to ’09 and ’10 while it was competitive there was still a lot of infrastructure that was built on the heels of a significant global shock. So hopefully that helps on oil. Everybody gets focused on the price of oil and to your point a comment about our resilience -- I don't know what's different about our company as opposed to when we went through a severe cycle other than our aftermarket capability and presence is bigger. Our footprint is bigger to even take advantage of more local market opportunities that are out there. Our product offering is broader, not only just to the oil and gas, the knock on chemical business, other things that are there. And the other thing that I can tell you is as opposed to five years ago, four years ago installed base out there is now four, or five years older than it was then. So that hasn't changed.

Thank you. Our next question is from Nathan Jones of Stifel, Nicolaus.

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

There is but we probably have to get back to you. I have a lot of numbers in my head but that’s one of them that I have got.

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

I mean I can tell you, going to last year and years prior where our backlog was up in the high single digits, low double digits. One thing we knew was when that product was ready, it was going to be taken. And we cleared a lot of – if you will actually look at the year-over-year compare a lot of last year was in a sense driven up from prior years because we had a lot of past-due backlog to get out the door, and this year it's certainly less of the case. So we always want to continue to -- we want to have zero past-due backlog frankly but the fact is we've driven it down quite a bit with improved execution and that just means it's not on the critical path. So what I will tell you is as long as we continue to execute well and the other factors that I described to you don't come into play that is for some reason they need to accelerate these projects for fear that costs are going to go up significantly, like you saw on our way – or I can’t imagine at this point of this investment cycle on these projects which would cause them to shut the project down because there’s already – they bought the land, held the piping there, the long lead time vessels are there and I guess I could [add] them something but the fact is I think that's what's going to drive it over that period of time.

Thank you. Our next question is from Joe Ritchie of Goldman Sachs.

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

Yeah, and if you’d allow me, let me give you the opportunity. I think there's been some confusion. When we talked about our guidance relatively flat, constant currency basically what we’re saying is we see revenues flat for the year, and when you look at our P&L remark around constant currency was if there is any significant moves in currencies from this point on, obviously that’s going to impact it as you saw it did even in the month of September Q3. So let me make sure we clear that up. Now as we look going forward we've seen some slippage. We've taken that into consideration in our guidance. We have more backlog than we did last year, if you think about it the backlog was up, for instance, last year. The aftermarket backlog is up versus last year. So that's the underpinning where -- why we put out relatively flat for the year which you can reverse engineer to what you have as a fourth quarter revenue number.

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

Well, no, no, hand-off. I mean it’s going to be project by project. Again aftermarket tends to be shorter cycle, the run rate business does as well but -- I can tell you the way we run our business we go side-by-side in we forecast as we look at the projects when they’re due -- when we expect them to do, what we’re hearing from the customer, that can obviously change. But that's certainly how we build up the forecast.

Thank you. Our next question is from Brian Konigsberg of Vertical Research.

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

I think I’ve made my comments – I mean this could persist things slipping from one quarter to the other. But the point is what’s slipped into this last quarter maybe next quarter and what may slip going forward, keep in mind Q4 as consistently I can't think of a quarter certainly since I've been here is our biggest shipment quarter. There is a whole host of reasons for that. Lot of customers, their budgets reset at the beginning the year. They want to make sure they get things in especially in emerging parts of the world. It's just the way the cadence of our business is a lot of stuff is shipped in Q4. So when we look at our forecast what we did is we built it up by the project, we look at our run rate business and our quick ship business and that's how we forecast Q4. Things can impact that. Obviously if there's some big push to get all the equipment in, that could create an upward bias. If there's for some reason people would even slow down little bit further that could impact it as well and obviously who knows what’s going to happen with currency at that point in time. But really our forecast in the fourth quarter is based on -- if you look sequentially over the last couple of years it’s been well over 100 million Q3 to Q4 increase in our revenue side. And the underlying that in the EPS is what component of that is run rate and aftermarket business versus some projects. Obviously aftermarket has more contribution to the EPS line.

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

Also it’s fixed cost leverage. If you look at our leverage across G&A but Brian that's why we put a range out there is because if we could -- if we could predict to a point in time that’s just not the nature of our business, again in our world a project is years, not days that's typically why we have out there. And we just take assumptions at a point in time, we have a currency in a point of time, we look at our backlog and the things that you mentioned as well, we’ve got of a higher aftermarket backlog than we had at this time last year. We look at things like that to say. But what – there is a lot of things that can happen. I mean look at what happened with low-lying currency you this quarter, that can flip next quarter. We can't predict that or forecast that, we don’t even try.

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