Flowserve Corporation (FLS) Q2 2008 Earnings Report, Transcript and Summary

Good morning. My name is Terry and I will be your conference operator today. At this time, I would like to welcome everyone to the Flowserve Corporation Q2 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. I'd now like to turn the call over to Mr. Zac Nagle, Vice President of Investor Relations. Sir, you may begin.

Thank you, operator. Hello everyone and thank you for joining us. Welcome to Flowserve's second quarter 2008 investor conference call. Today's call is also being webcast with our earnings presentation on our website at flowserve.com. Just click on the Investor Relations tab to access the webcast and the accompanying presentation. Before we get started with the presentation, I want to make one brief note. For those of you who have accessed today's call through our dial-in phone number and also wish to follow along with our earnings presentation slides on our website, please click on the click here to listen via phone icon at the bottom of the event details page. I'd also like to note that our webcast will be posted on our website for replay approximately two hours following the end of the call. The replay will stand aside on demand for the next few months. Joining today are Lew Kling, President and CEO of Flowserve; Senior Vice President, Chief Financial Officer, and Latin America Operations, Mark Blinn; and Vice President and Chief Accounting Officer, Dick Guiltinan. Following our commentary, we will begin the Q&A session. Regarding any forward-looking statements, I’ll refer you to yesterday's earnings release and 10-Q filing and today's earnings presentation slides deck for Flowserve's Safe Harbor on this topic. All of this information could be found on Flowserve's website under the Investor Relation's section. I also encourage you to read these statements very carefully with respect to our conference call this morning. The information in this conference call including the initial statement from management plus their answers-and-questions related in any way to projections or other forward-looking statements are subject to Flowserve's Safe Harbor. Now I would like to turn it over to Lew to begin the formal presentation.

Thanks, Zac and good morning. It's a pleasure to welcome you to our 2008 second quarter conference call. I'm pleased to report that the second quarter was another terrific quarter for Flowserve with continued strong execution and outstanding financial results. These results met or exceeded all our internal expectations which is why we're now significantly raising our full-year earnings per share guidance to between $7.20 and $7.50 per share from our previously announced $5.90 to $ 6.20 per share. These record second quarter results show the continuous strength in our end-markets, strong leverage in our income statement, and most important, successful execution of our key strategies, including significant organic growth, success in our aftermarket initiatives, additional process excellence improvements, further SG&A reduction, and strong margin improvement. When looking at the full year, these financial results along with the continued penetration of our key end markets, further operational excellence improvements within our manufacturing facilities, continued margin enhancements, improved traction in our tax-planning initiatives, and the increased confidence we have in our ability to continue to execute and grow in this environment caused us to raise our outlook again for 2008. During the next few slides, I will cover some of the significant company highlights for both this quarter and the first half of 2008 as well as the key performance metrics achieved during the quarter. Next, as I have done in the past couple of conference calls, I'll touch on a few of the key global project wins we've had over the past year or so. I'll highlight just a very few subset of these project wins which should show more clearly how we're using our global footprint in executing in strategic global operations and key market segments to position the company well for success over the long term. In the back half of the presentation, I'll review our primary end-markets, which are an area of significant focus for the company. This discussion [inaudible]. Slide three covers the primary highlights of the second quarter of 2008. We delivered record fully diluted quarterly earnings per share of $2.13, up nearly 92% over the same period last year. This significant increase in earnings was due to a number of factors, including increased consolidated operating margin of 440 basis points to 14.8%, over 24% increase in sales, a 360 basis point improvement in gross margin, and a further reduction of 80 basis points in SG&A expense as a percentage of sales. We also delivered our sixth consecutive quarter of bookings in excess of $1 billion, recording bookings of over $1.3 billion, up 24% over the previous year. This increase was driven primarily by continued sector strength with notable growth continuing in the power and chemical markets. We continued to drive strong manufacturing throughput in the second quarter, delivering record second-quarter sales of almost $1.2 billion, up over 24% over the previous year and recorded very strong gross margin performance of 360 basis points to over 36%. This gross margin increase was primarily due to pricing, higher sales volumes positively impacting fixed cost absorption, continued strong execution on our operational excellence programs, and the continued strength of the company's end-user aftermarket strategy which drove high levels of aftermarket sales. We also delivered well against our ongoing internal initiatives of reducing SG&A as a percentage of sales, growing SG&A to 21.7%, an additional reduction of 80 basis points versus the same quarter last year. With respect to our end markets, we continue to see broad strength during the second quarter based on continued global infrastructure investment. This infrastructure investment also yielded strong aftermarket growth when combined with the tremendous success of our end-user aftermarket strategy, particular in our Pump division. Slide four covers the key year-to-date highlights for 2008. The team delivered records earnings per share of $3.66 in the first half, up nearly 117% over the same period last year. This significant increase in earnings represents consistent strong execution against our commitment to create ongoing value for our shareholders. In the first quarter of this year, we achieved a consolidated operating margin of 11.9% and in the second quarter, we achieved an all-time record quarterly consolidate operating margin of 14.8%. This calculates to a first half consolidated operating margin of 13.5%, up 400 basis points versus the first half of 2007. We are extremely pleased with our consolidated operating margin trend and we remain fully committed to delivering 15% by 2010. Bookings for the first half of the year are up over $2.7 billion, up almost 28% from the last year's first half and another first-half record for the company. We also delivered record sales of over $2.1 billion, up 24% from a year ago. And we saw a significant gross margin expansion of 280 basis points to 35.5% and SG&A reduction as a percent of sales of 130 basis points to 22.5%. We also continued to drive higher backlog, while achieving strong sales to a record backlog of over $3 billion, up nearly 34% versus December 31, 2007. So as you can see, the first half was tremendous for Flowserve and the reason I feel confident in significantly raising our 2008 target earnings per share to between $7.20 and $7.50 per share. Slide five outlines in detail many of the second quarter highlights I discussed on the previous slides. As I've noted earlier, the company delivered tremendous leverage throughout the P&L during the quarter, delivering operating income and earnings per share growth more than three times the rate of sales growth. Slide six shows our progression of bookings… booking success since the story of 2004 and highlights the tremendous growth in bookings we’ve driven since the back half of 2005. Slide seven highlights our sales since the beginning of 2004 and the average conversion cycle we've talked about many times between a booking and a sale, which is averaged about 12 months. I would like to remind everyone that this is an average conversion cycle with valves and seals being shorter than 12 months and pumps on the average being longer. As I've noted in previous presentations, as projects continue to increase in size, complexity, and scope and customers continue to order earlier to help ensure adequate capacity, the conversion cycle could extend another month or so. Slide eight highlights an important element of our business model that we've talked about for some time, that being the strength of our global footprint and how we leverage it. This chart represents a small sampling of our large project wins from across the globe over the past year or so and many of our key industries including oil and gas, power, chemical, water, and general industries, specifically pulp and paper and mining. We've updated the chart with some recent wins that were not shown at our first quarter conference call. The strength of this snapshot is not just a fact that we are a leader on these projects around the globe, but also represents to continued aftermarket opportunities that projects like these represent for our future. Our continuing investment in our global manufacturing and quick response set of footprints across our key manufacturing and infrastructure growth areas continues to be a significant competitive advantage for the company and a significant benefit to our customers. Slide nine begins our view of our core markets, oil and gas, power, chemical, water, and general industries, supported by considerable independent market research conducted by a number of data sources highlighted on the following five market perspective slides. We've also added a new graph on each slide that shows the total combined available original equipment and aftermarket estimate for the past 11 years for pump, valves, and seals. The bottom of each bar represents mature markets such as North America and Europe while the top of each bar represents the developing markets, including China, India, Africa, Middle East, and Latin America. The two major points on all five charts are the increasing influence being felt by the developing markets, but equally important is the continuing positive growth trends from the mature markets. In the oil and gas market, we continue to see robust business activity and planned projects on a global scale. Investments have been made in upstream, midstream, and downstream projects and they are being made in multiple regions throughout the globe. Upstream investments focused on finding and producing more crude oil are being fuelled by the projected growth of global consumption as well as the projected depletion rate of existing fields. As we've discussed in the past, a majority of the new oil being developed is not of the conventional light crude variety. In the near term, it is more of what we call heavy oil required… requiring more complex recovery methods. A significant amount of longer-term oil will most likely be coming from deepwater or subsea production fields. The challenges of extracting this oil continue to stretch apply technology, which is where we believe Flowserve is a leader. Our continuing research and development investments and collaboration with key customers has supported the development of products and services required by these more complex applications. The byproduct of these complex recovery systems is different varieties of crude oil, which require different methodologies to upgrade or refine the product for market. Most existing refineries were built to handle the conventional light crude, which dominated the market until recently and without modification, these refineries will not be ready to process the variations found within heavy oil. Many existing refineries are in the process of upgrading their operations to allow the flexibility to handle the various types of crude oils arriving to their facilities. There are also several new refineries in both the planning and construction phase, which are requiring to meet projected demand growth, particularly in the Middle East and Asia. The market is also seeing several of the heavy oil producers getting upgraders or small-scale refineries at or very near their oilfields. These upgraders allow the producer to develop an improved grade of crude oil for delivery to the market. All these needs are driving continued investment in the downstream side of the market where we are a leading supplier for pumps, valves, and seals, including those required for the new refining of upgrading the process, which bodes well for our business going forward. In the area of natural gas, there continues to be an increased focus on utilizing this form of fuel for its cleaner environmental properties. Significant investments are being made in the upstream portion of this market to find and develop new fields worldwide. In fact, one of the largest gas finds, it’s in the United States right in our own backyard near our Irving Texas Corporate Headquarters with the development of the Barnett Shale discovery. Since the location of many of the newer gas fields are not adjacent to the ready customer market, investments in liquefied natural gas or LNG are forecasted to remain strong. As I have mentioned in prior calls, we are well positioned to win important project opportunities in this segment of the market, such as our previously announced major win in Qatar. Oil and gas is a core market for Flowserve and we will continue to invest to increase our market share in this very important industry. Slide 10. In the power industry, investment continues and the forecast of growth well into the future. As I've mentioned in previous calls, industry analysts are forecasting a doubling of demand for electricity on a global scale over the next few decades. This growth in demand is directly coupled with significant development of infrastructure occurring around the globe, particularly in the Middle East, China, India, and South Africa. This demand requires a construction of new power plants ranging from hydroelectric to nuclear with the majority still being coal-fired plants. An interesting data point is the recent press coverage on the expansion of coal mining. In fact, closed coal mines are being reopened and reduced production mines are being expanded to meet the proposed increases in demand for coal. Therefore, the projected growth in the power industry is also having an expansion effect on the mining industry as well. Coal's prevalence in the power industry is driven mostly by its lower cost, lower plant construction cost, and the speed at which a new plant could be brought on line. This increase in coal-fired plants is also increasing the concerns about CO2 emissions. This in turn is driving activity levels in the development of carbon capture and storage methods, also known as carbon sequestration, where our pumps, valves, and seals should play a major role. Many of these coal-fired plants are projected to use advanced cycling techniques, which operate at higher temperatures and pressures with reduced emissions. These approaches are referred to as supercritical and ultra supercritical power plants. We've continued to invest in research and development for new products specifically suited for these applications. In addition, utility companies are making investments where practical in the refurbishment and upgrading of existing power plants to increase their efficiency and lower their emissions. Due to the need to control CO2 emissions, many of the utility companies are now looking at expanding their use of natural gas and nuclear material as alternative sources of fuel. Nuclear is forecasted to experience a significant increase in investment worldwide, as the cost for all fossil fuels remains high. And with the pending government application of carbon credits, the operating cost for nuclear power plants could even become more attractive. Obviously, a slight benefit of nuclear power generation is that it produces zero carbon emissions, which is driving new power plant planning and licensing worldwide for more than 100 units to be built by the year 2020. As a leading producer, and products and services to the power industry, the projected growth in this segment positions us well to grow our market share in this market. In the chemical industry, there continues to be a focus on investment into lower-cost regions of the world. This focus is driving strong growth in new plant construction in both Asia and the Middle East. Several of the oil companies are also partnering with chemical companies to add petrochemical plants adjacent to refineries such as those planned in Brazil, the Middle East, and China. As an example, it was recently announced that the current ethylene shortage in China is driving investments in large-scale integrated projects combining a refinery and a petrochemical facility on the same campus. Our investments in manufacturing, service, and support capabilities in China have positioned us well for that growth opportunity. The chemical market is also seeing significant growth plans in India. Recently, it was announced that India plans to increase its chemical output production 12% to 15% by 2012, which will require increased investments in new plant capacity. This market segment continues to see strong growth in coal gasification and liquefaction as the industry continues to look for alternatives to higher-priced petroleum feedstock and Flowserve had several heritage brands specialty products designed especially for this critical application. The chemical industry has continued to show strong opportunities for growth in our product and services and our expansion investments in China, India, and the Middle East has positioned us well to gain market share in this industry. In the Water market, the outlook remains positive due to persistent need for freshwater worldwide. Forecasts continue to show sustaining growth in this industry with strong growth in the development areas of the global market. These are two critical factors in improving the availability of freshwater to the global population. The first is obviously finding or producing potable water and the second is the ability to move large sums of water to areas, which need the water but do not have local access. This creates the requirement to have infrastructure, which is capable of moving large volumes of water over long distances. Our line of large water and volute pumps used in water transport, flood control, and irrigation applications supported by our Changsha Pump Company joint venture in China provide us with the opportunity to grow our share in the worldwide water market. As researchers and government look at how to answer the need for more portable water, there was a growing interest in desalination as a viable solution. Analyst projections continue to support the forecast that potable water produced by desalination should double by the year 2015. Slide 13 shows the market grouping referred to as general industries. This group contains industries such as mining and ore processing, district heating and cooling, agriculture, government, pulp and paper, and food and beverage. None of these individual industries accounts for more than 5% of our total business. And in fact, the volume produced by many of these industries represents no more than 1% of our bookings. Also, within this part of the business are the orders that flow through general distribution, which serves a broad array of customers, which may include companies in the oil and gas, power, chemical, or water markets as well as other general industry markets. General industries also contains the emerging biofuel market, which we're working to ensure that we will be a major provider of pumps, valves, and seals and services to this industry. In summary, the second quarter was another terrific quarter for Flowserve and I'm extremely proud of the Flowserve team around the globe for their outstanding performance. Once again, they not only met but many areas far surpassed our already high expectations with respect to the quality of their overall execution, which as I've noted many times before is probably the most important factor to our success as a company. We have continued to demonstrate our ability to deliver strong financial performance across the P&L in bookings, revenue, operating income, and earnings per share and have also continued the strong momentum we had when we exited 2007, taking advantage of the outgoing strength of our key end markets as well as our global footprint in driving strong bottom-line earnings through the operational excellence and leveraging our P&L. With respect to our focus going forward, we will continue to strategically deploy assets and resources on a global scale to provide local support to our customers. And we will continue to focus on our execution against the critical customer-centric metrics of on-time delivery, performance, and reliability. And lastly, we will continue to work to ensure that shareholder and Flowserve employee goals are tightly aligned by continuing to link Flowserve compensation plans to Flowserve company performance. Now, at this time, I would like to turn the presentation over to Mark to discuss the segment results and our financial performance in more detail. Mark.

Thank you, Lew. And good morning, everyone. As Lew mentioned, we are very pleased with our second quarter results, and more important, we're pleased with the progress towards our long-term objectives and we're confident we will achieve them. During the second quarter, we saw continued strength in orders, highlighted by our strong aftermarket growth as we continued to execute on our aftermarket strategies. In fact, if you look at our growth in the aftermarket business over the last year, you can see that we are quickly becoming a $2 billion aftermarket business, which is profitable, high-margin, sustainable business. We also continue to see strong global sales growth. As we have discussed many times, over two-thirds of our revenues are international and two-thirds of our operations are international. We are truly a global company with a diversified operating and sales platform. Looking at gross margins, last year at this time, we saw a good improvement in gross margins despite mix shift to original equipment in the Pump division which showed that we were driving improvement through pricing, operational excellence, and absorption. This year, we've seen a slight shift to more aftermarket in the Pump division and margins have expanded significantly, which demonstrates that independent of mix, we're continuously and systematically improving our margins in all three divisions. In fact, in the Seal division, this quarter, we saw a 10% shift to more original equipment and their margins expanded. Looking at SG&A, we remained focused on driving SG&A as a percent of sales down to 20%. During the quarter, SG&A increased $41 million and once again, approximately half of that was selling related. We also invested in R&D. Also in this number, we've included the Niigata SG&A which was not consolidated last year and we saw a $14 million increase from currency. We did have some legal recoveries in our Seal and Valve division that were basically offset by Niigata integration expense in the Pump division. Looking at the tax rate, we did have a $0.16 benefit from tax items, but more important is that we've seen our structural rate go down through planning. Going forward, we expect our structural rate to be at or below 29%. We also expect to see an additional benefit of 2% to 4% in the rate in 2008. The important point is that we will continue to invest in tax planning going forward to drive the rate down. Turning to cash flow, oftentimes in the mid-year call, we talk about the fact that we use cash in the first half of the year and generate cash in the back half of the year. But when you look at the second quarter results, you can see we had a strong cash quarter. When you consider during the quarter, we used $27 million to wind down factoring and $50 million to top up our U.S. pension plans, both things we discussed at the beginning of the year. Bottom line is that we've made tremendous progress towards our objectives and the second quarter results show that. But the real story is the 15,000 motivated Flowserve employees that are committed to meet and exceed these objectives. Looking at our second quarter, we saw strong orders and top-line growth, tremendous margin expansion, and great earnings leverage, as net earnings grew four times sales in the quarter and five times year-to-date. Looking at bookings, bookings increased $257.3 million or 24.4% to $1,310,600,000. Sales increased $226.9 million or 24.4% to $1,157,600,000. Gross profit grew an incredible $115.6 million or 38.2% to $418 million and gross margins expanded 360 basis points to 36.1%. This has been driven by pricing, operational excellence, and absorption. We also did see a 200 basis point shift to aftermarket in the Pump division. SG&A increased $41.4 million or 19.8% to $250.9 million and SG&A as a percent of sales decreased 80 basis points to 21.7%. Again, half of that was selling related, but we are also pleased to note that corporate expense in that segment as a percent of sales was at 3%, which is a target we committed a number of years ago. Operating income increased $74.7 million or 77.1% to $171.6 million and operating margin expanded 440 basis points to 14.8%. Net earnings increased $59.7 million or 94.5% to $122.9 million and earnings per share increased $1.02 to 92% to $2.13. For the year, the theme is consistent. Bookings grew $597.9 million or 27.9% to $2.740 billion. Sales increased $416.8 million or 24% to $2,150,900,000. Gross profit increased $195.9 million or 34.5% to $763.8 million and gross margin expanded 280 basis points year-to-date to 35.5%. Turning to SG&A, SG&A for the year has increased $70.9 million or 17.2% to $484 million and SG&A as a percentage of sales has decreased 130 basis points to 22.5%. Last year, we decreased SG&A as a percent of sales 280 basis points and so far this year, we've increased it another 130 basis points. Operating income increased $126 million or 76.7% to $290.3 million and operating margins expanded 400 basis points for the year to 13.5%. Our second quarter and year-to-date operating margins show great progress towards our 15% commitment. Turning to the Pump division, the Pump division had another strong quarter, highlighted by continued strength in pricing, great execution on their aftermarket strategies, benefits from operational excellence, and the benefit from being a leading manufacturer of high-end specialty pumps. In the Pump division, bookings increased $120.2 million during the quarter or 19.5% to $736.4 million, sales increased $108 million or 20.6% to $633.2 million, gross profit increased $61.9 million or 43% to $206 million, and gross margin expanded 510 basis points to 32.5%. This was driven by pricing, operational excellence, great aftermarket execution, and we did see the impact of some specialty pumps and the good news is we have more in backlog. SG&A increased $23.8 million or 29.7% to $103.8 million and SG&A as a percent of sales increased 120 basis points to 16.4%. I do want to point out that again, half of this was selling related but this amount also include $7 million impact from the Niigata integration expense and also the inclusion of their SG&A in our consolidated P&L. Operating income increased $38.2 million or 58.6% to $103.4 million and operating margin expanded 390 basis points to 16.3%, that's impressive. Looking at the year-to-date numbers, bookings increased $352.3 million or 27.6% to $1,626,700,000. And as Lew mentioned in our press release, we do expect the second-half bookings to be higher than the first half. Looking at sales, sales increased $250.5 million or 26.5% to $1,194,300,000. Gross profit increased $119.5 million or 45.8% to $380.6 million and gross margin in the Pump division expanded an impressive 420 basis points to 31.9%. SG&A increased $43.5 million or 27.7% to $204 million and SG&A as a percent of sales for the year has increased 20 basis points to 16.8%. Again, half of that is selling related and that also includes an $8 million impact year-to-date for Niigata, the integration and the inclusion. Operating income increased $74.8 million or 69.9% to $181.8 million and operating margins expanded 390 basis points for the year to 15.2%. The Pump division has had strong operating income flow through for the quarter and the year. If you look at our supplemental slide on the pump mix, you can see that we did see a 200 basis point shift to aftermarket for the quarter and the year. But the real story is the strong growth in aftermarket bookings and sales. For the quarter, bookings grew 24% in aftermarket and for the year, 21% and sales grew an impressive 29% in aftermarket for the quarter and 32% year-to-date. Turning to the Valve division, the Flow Control division had another impressive quarter. It was highlighted by strong order growth, reflective of the 12-month lag from pump orders. Also, they’re seeing the benefits of pricing power, not only due to the strength in the markets but also because of their ability to deliver high-end, high-quality products on time. As with the other divisions, we've seen excellent execution on operational excellence and for the Valve division, Lean and CIP are really kicking in in 2008. And we’ve also seen strong execution on cost controls. Looking at the results, bookings increased $114.7 million or 36.4% to $429.6 million. Sales increased $85 million or 29.8% to $370.2 million and gross profit increased $31.5 million or 31.1% to $132.9 million. Gross margin expanded 30 basis points in the quarter to 35.9%. If you look at the gross margin for this division, this has been a 2.5-year story where margins have continued to expand. They’ve executed on a number of initiatives to improve gross margin and there is more in the pipeline. Looking at SG&A, SG&A increased $10.3 million or 16.8% to $71.7 million and SG&A as a percent of sales went down 210 basis points to 19.4%. Similar to the other divisions, half of the increase is related to selling. They are investing heavily in R&D and they did in the quarter receive a $2 million benefit from a legal resolution. Operating income for the Valve division increased $21.7 million or 52.8% to $62.8 million and operating margin expanded an impressive 260 basis points to 17%. Looking at the year, bookings have increased $195.5 million or 31.3% to $819.5 million. Sales increased $116.8 million for the year or 21.1% to $670.5 million. Gross profit has increased $44.6 million or almost 23% to $239.1 million and gross margin has expanded 60 basis points during the year to 35.7%. SG&A in the Valve division increased $18.5 million or 15.4% to $138.5 million and SG&A as a percent of sales has decreased 100 basis points for the year to 20.7%. If you look at income from affiliates, I do want to highlight this for a moment. Income from affiliates increased $2.3 million or 74% to $5.4 million. This really demonstrates the significance of these strategic joint-venture relationships that we have around the world. They add value to our bottom line. Operating income increased $28.5 million or 36.8% to $106 million and operating margin for the year has expanded 180 basis points to 15.8%. The valve division has been focused on execution and cost control while continuing to invest in technology and their high-end product offering, and their efforts are paying off. Looking at the next slide at our Seal division, they had a strong quarter highlighted by strong orders and top-line growth as their ability to deliver timely quality service has increased demand for their seals. They've also been able to sustain very high margin growth and they have continued focus on standardizing their platform to deliver consistent worldwide service. Looking at bookings, bookings in the Seal division increased $31.1 million or 22.5% to $169.5 million. Sales increased $39.5 million or 29.4% to $174 million and gross profit increased $18.4 million or 30.1% to $79.6 million. Gross margin expanded 20 basis points to 45.7%. These are very high gross margins. And as I mentioned earlier, they did see a 10% shift to more original equipment during the quarter. SG&A increased $6.9 million or 18.7% to $43.8 million and SG&A as a percent of sales decreased 230 basis points to 25.2%. Similar to the other divisions, half of this is selling related. They did have a benefit from the resolution of a legal matter during the quarter of approximately $2 million. Operating income increased $11.6 million or 44.8% to $37.5 million and operating margin expanded 240 basis points in the quarter to 21.6%. If you look at the story for the year, it’s consistent. Bookings for the year have increased $61.8 million or 22.2% to $340.8 million. Sales have increased $60.9 million or 23.1% to $324.6 million. Gross profit in the Seal division has increased $27.2 million or 23% to $145.6 million and margins year-over-year have remained flat at a very high 44.9%. SG&A has increased $14.3 million or 20.1% to $85.4 million and SG&A as a percent of sales has decreased in the Seal division for the year 70 basis points to 26.3%. Operating income in the Seal division increased $12.9 million or 25.3% to $63.9 million and operating margins have expanded 40 basis points in the year to 19.7%. This is the Seal team that is constantly differentiating itself from its competitors and the high margins reflect that. Looking at working capital, we saw growth in working capital during the year, which was expected. We also saw a significant benefit from continued advance payments from our customers which we not only view these as sources of cash but is a strong vote of confidence from our customer base. Also, if you compare our working capital metrics to last year, they're consistent when you consider the sales and the backlog growth. Comparing our working capital to year-end balances, you can see that receivables increased $253 million since year-end to $920 million. This is driven by $105 million of increased progress billings as we billed projects to ship. Also, we had a $68 million impact from winding down our factoring which we talked about at the beginning of the year and also we've seen the impact of increased sales. Inventory since year-end has increased $213 million to $893 million. This includes the impact of $172 million of work in process, primarily in the Pump division and also an increase of $50 million in finished goods which were goods waiting to be shipped to our customers. You can also see that in advance cash, advance cash increased $96 million, again a vote of confidence from our customers. We are very comfortable with our working capital position. Turning to cash flow, and as I mentioned earlier, we've often said that we use cash in the first half of the year and generate cash in the second half of the year. When you look at our operating cash flow year-to-date, you can see that we used $178 million. Now if you compare that to our first quarter where we used $173 million, you can see that this second quarter was relatively flat. Now if you consider that during the quarter, we used $27 million to wind down our factoring and we also topped up our pension plan to the amount of $50 million, it was a strong cash flow quarter. Looking at capital expenditures, year-to-date, we spent $38 million. We do expect higher spend in the second half. Also, we've returned $58 million to our shareholders year-to-date in the form of dividends and share repurchase. If you look at our balance sheet, it's strong. We have a lot of flexibility to invest in high-return capital expenditures, execute on our repurchase program, provide return to our shareholders through dividends, all the while maintaining flexibility for strategic acquisitions. Now, I'll turn to the full-year outlook. If you look at our gross margin initiatives and we often get asked about material price increase and we have been able to more than offset that through pricing, supply chain, and low-cost sourcing. Another thing that has been driving our gross margins is our end-user strategy that’s been driving our aftermarket growth. If you look at our initiatives around SG&A, we're very pleased to see that we scaled corporate overhead to 300 basis points and we will continue to drive that down. Now some of the incremental expense has been strong selling expense, but that’s tied to bookings, which is good for our company. Looking at our tax rate I mentioned, we see a structural rate going forward of 29% or less and additional benefits in '08 of 2% to 4%. The result is that we raised our guidance to between $7.20 and $7.50 for the year. Looking forward, well, there is a lot to look forward to. We do expect ongoing global infrastructure investments in our core markets to present significant opportunities in 2008 and beyond. We will maintain focus on our capacity in globalizing our assets and also automating our capacity to drive incremental throughput. We will maintain focus on our strong aftermarket strategy. I think we've seen the benefits of that focus. We focused on cost containment, gross margin improvement, and tax-planning strategies to deliver strong operating profit and earnings per share. All the while we'll maintain financial flexibility to focus on delivering strong cash flow. As I mentioned, we do expect our structural tax rate going forward to be 29% or less. As we mentioned before, execution remains the biggest key to our success. Also, I do want to mention that we were coming out of this quarter as a management team more confident than ever that we will deliver on our 15% operating margins. And with that, I'll turn it over to Zac.

Thanks, Mark. Operator, I think we are ready to take questions. Question and Answer

[Operator Instructions]. Your first question comes from the line of Amit Daryanani with RBC Capital.

Good morning, guys. Just a quick…

Amit, did we lose you?

We will move to the next question. Your next question comes from Charlie Brady with BMO Capital Markets.

Hey, thanks. Good morning, guys

Hi, Charlie.

Hey, just a quick clarification on the tax rate just so I understand I'm clear. Structural rate of 29% but then reported rate, 200 basis points to 400 basis points below that?

That's right, Charlie, and let me make sure I'm really clear on this. What we talked about around FIN 48, there is the aspect to the structural rate and then there can be fluctuations around that for a resolution of certain matters, but also from certain tax-planning items. So what we are saying is, we see our structural rate going forward to be 29% or below. We do see additional benefits of 2% to 4% through the back half of the years and those could be resolution of tax matters and/or the benefit of tax-planning initiatives. But you are right, 29% or below is our structural rate and additional 200 basis points to 400 basis points in '08.

Okay. Thanks for that clarification. As we look at the bookings, particularly on the Pump business, as we had that 200 basis point shift and Q1, we had another 100 basis point shift. Are you seeing a shift towards the aftermarket business happening sooner than you might have envisioned? Or given the fact that for Q3, for instance, we're going against a 42% aftermarket mix, do you expect that the swing back towards more OE in the back half of '08?

Yeah, I don't want to call mix going forward because if I would have done it last year, I would have been wrong. And that's primarily driven by our tremendous success in executing on our aftermarket strategies. But Charlie, you can't ignore that the mix in orders over the last year has really been more biased toward original equipment. What we've seen is just tremendous success on our aftermarket strategies. And the other thing I'll always remind you is we are not a quarter-to-quarter business. You can't call a trend from either one but if you look at our full-year trend so far, I think that's indicative of where we are going; strong aftermarket growth, but we still see a lot of project work and you've seen the bias to more original equipment. So I would say that is a leading indicator of what you should see in shift going forward. But we just don't want to call it because we're really lighting it up on this aftermarket strategy.

Okay. One more question, I will get back into queue. Just in terms of the bookings mix by end-market, it looks as though this half of the year, the oil and gas business has been trending down as part of the overall mix and you were ticking it up on the chemical and the power again [ph]. So your mix of business is a bit more balanced out. Is that what you expect going forward? I would assume that that's more of a positive in that you're seeing a pickup from some other markets that have been maybe not a great [ph] contributor in the past?

Well, I mean, I certainly don't want in any way to infer that we are calling the oil and gas markets to be going down because that's just not the case. They've remained strong but what you've seen, and we’ve often talked about our process, is selectivity. And we certainly have been very selective and I think that’s reflective in our margins and also it’s reflective in our aftermarket growth. But, yes, we have seen growth in the other sectors, chemical and power, but oil and gas remained very, very strong and very, very profitable for us. So I think what you should see going forward is that we will continue to drive selectivity through our processes and we will continue to see opportunities to take advantage of aftermarket and we are going to capitalize on the chemical and the power markets, but it is balanced. It is balanced for a number of reasons, that's the way the markets are, but also it's balanced around selectivity.

Right. Thanks very much. Great quarter, guys.

Thank you.

Thank you.

Your next question comes from the line of Amit Daryanani.

Hi, good morning, guys.

Good morning.

Hopefully, the line works this time. I think a great quarter by the way. Just a couple of quick questions. On the Pump segment, the bookings, it looks like it slowed down a bit at 7.5% growth this quarter. Could you just have what drove that? And I know, Lew, you mentioned that we should see the back-half bookings being stronger than the back half of '07, are you talking dollar amount or are we talking the growth rates?

Yes, we're talking dollar amounts. And look, that's the way we run our business as we look at the dollar amount and the orders because from quarter-to-quarter, you're looking at different comparers. But, the other thing we'll remind you is, Amit, you may have seen the organic rates in the 7% range for the second quarter if you look at the organic growth rates for the year. And again, we are not a quarter-to-quarter business. Orders can move from one quarter to the other and that's why we found it was important to talk about the back half of the year because we do have very good visibility into our markets, we go grow through a detailed process and we wanted to make sure that we understood that our markets are good and we're executing well in tune [ph].

All right. And then if I just look at the overall bookings numbers on a sequential basis in Q2, it dropped 8% sequentially. It seems a little bit severe, at least compared to last year when the drop was about 4%. Could you just talk about why the sequential drop there?

Well, I mean, it's... again, they are still at very high levels and they did drop last year. And there is some that you can see if you look over the last couple of years seasonality as to how orders occur, last year is a good example and it's the way people set their budgets and so on and so forth, but again if we start looking it sequential from one quarter to another and try to call that a trend, I think we're going to be missing a lot of the messages that Lew talked about in his comments and it could be very simple that one was pulled up... came up into the first quarter that we thought would be in the second or slipped out of the second quarter into the third. So I would just caution you not to look too hard at necessarily the sequential bookings unless you're sustained over a period of time.

Fair enough. And then just finally, my final question would really be... if I look at incremental margins this quarter at around 33%, the full [ph] stat has been around 30%. Could you just remind us how should we think about the long-term incremental margins? I know you’ve talked about 25% historically, but it seems like we may have a step up over here, should be something at 30% is a longer-term sustainable rate?

Well, I mean, the incremental margins are going to be driven by comparers and so there is a couple of things to consider. Look at the SG&A initiatives that we put in place really in the first quarter of last year. Look also at some compliance costs we added last year... during the course of last year and that impacts incremental margins. I think the way you ought to look at it going forward is really around what our commitment is and that is that we want to drive this to 15% consolidated margins. The incremental margins can fluctuate from one quarter to another. They have been very, very strong. As you’ve seen, we've been able to grow operating earnings at three times the rate of sales, which really does drive through that. But at the end of the day, that is a metric we use for efficiency, but it's not necessarily the way we're driving our business. We're going to invest; we’re going to create a sustainable business. But I think if you look over the horizon, you see that we still have a number of initiatives that can drive incremental margin flow through.

Thanks a lot, guys.

The next question comes from the line of Scott Graham with Ladenburg Thalmann.

Hey, good morning guys.

Good morning, Scott.

I think you guys are going to have a good problem to have. It looks to me like the pace of cash flow is going to support a near-zero net debt a little out from a... a little bit more than a year from now. What's the plan there, Lew? What are you thinking in terms of capital deployment?

Well, we're not going to broadcast exactly what we're going to do. But as we’ve discussed many times, right now, we're not paying off debt. We're looking at other things like acquisitions and ways to return money back to the shareholders. We are in the middle of a buyback program and we increased our dividend last quarter by about 66%. So I don't think you'll see us go to a net debt of zero. We will probably continue to be where we are or maybe a little bit above.

Yes. And Scott, the terms [ph] we usually use is... when we go through our cash planning as we talk about at the beginning of the year and we talked about the uses of our cash and if you remember, still in the back half, we’ve got some significant capital expenditures that are coming on and those... you ought to view those as not only automating capacity but those were new market opportunities and so we will be deploying cash to new market opportunities and that's in Brazil and Russia and other areas of the world, continued investment in China and India. So you can look at that as an acquisition or your capital expenditure, it’s a buy versus build decision. As we mentioned, we also have plenty of capacity under our share purchase program and we want to keep flexibility around some strategic acquisitions. So we don't intend to let the cash sit idle, but we also don't see any benefit in paying out our debt at this point. It's termed out, it's very low-cost debt and we are happy with it.

Okay.

And one of the things we continue to do is we've mentioned is increase our number of QRCs around the world and that's basically following our customers, where our customers need us and that's where we are going to be.

Okay. If I just might follow up on that. If in fact you guys are contemplating additional acquisitions, I guess my question would be, where do you see holes in the portfolio? Is it an end market like desal or is it a region or is it a product line that you might want to get more involved in? Any color on that would be helpful.

We are constantly looking at all those things. As an example, in product line that we've mentioned this before in our valve line, we don't have a safety valve. I would like to have it but I don't need it because I have relationships with people that do have that. But it’s a possibility that if we had a chance to get it, we would. We are also looking at areas, as an example, we created a QRC in the Czech Republic. So there, we are looking at a place we wanted to be in. We are building a QRC. We decided to build versus buy in Vietnam because it was obviously nothing there to get. So it's a combination of all of it, really.

Yeah, I mean it's a great example that Lew highlighted, Scott, as if you think about our acquisition in Tulsa of basically sealing systems, which are auxiliary systems, it may have seemed like a small acquisition at the time but we’ve put substantial amount of capital in there and then we are leveraging that platform worldwide. So holes is a tough word to use in terms of our overall portfolio. But I would think of it in terms of opportunity and it can come in the form of capital or acquisitions as well, but we'll see them as they come along. The important message, I think is that we are not in any defensive position where we have to make an acquisition.

Understood, thank you.

You’re welcome.

I think we have reached the allotted time for today's call. Do you have any closing remarks?

I would like to thank everyone for joining and we look forward to speaking with you soon. Thanks.

This concludes today's call. You may now disconnect.