Flowserve Corporation (FLS) Q2 2012 Earnings Report, Transcript and Summary

Welcome to the Flowserve Q2 2012 Earnings Conference Call. My name is Kim, and I will be your operator for today's call. [Operator Instructions] I will now turn the call over to Mr. Mike Mullin. Mr. Mullin, you may begin.

Thank you, operator. Good morning, and welcome to Flowserve's Second Quarter 2012 Earnings Conference Call. Today's call is being webcast with our earnings presentation via our website at flowserve.com. Simply click on the Investor Relations tab to access the webcast and the accompanying presentation. The webcast will be posted at flowserve.com for replay approximately 2 hours following the end of the call. The replay will stay on the site for on-demand review over the next several months. Joining us today are Mark Blinn, President and CEO; Tom Pajonas, Chief Operating Officer; and Mike Taff, Chief Financial Officer. Following our commentary today, we will begin the Q&A session. Regarding any forward-looking statements, I refer you to yesterday's earnings release, 10-Q filing and today's presentation slide deck for Flowserve's Safe Harbor statement on this topic. All this information can be found at Flowserve's website under the Investor Relations section. We encourage you to read these statements carefully with respect to our conference call this morning. And now I'd like to turn it over to Mark to begin the formal presentation. Mark?

Thank you, Mike, and good morning, everyone. I am pleased with our second quarter results. The progress we have made operationally, as well as the strategic actions we have taken, are positioning our business to capitalize on the continued global trend towards infrastructure spending, which will enable us to continue to grow and drive shareholder value. I am very proud of our employees' constant focus on serving our customers, while we make these operational enhancements. In spite of what appears to be another summer of uncertainty with the European debt crisis, the looming U.S. fiscal cliff and concerns over the rate of economic growth in China, we remain optimistic about the prospects for our end markets and our ability to capture profitable growth across our diversified markets. I'm also very pleased with the improved quality of backlog resulting from our disciplined effort around pricing and selectivity, as well as the leverage resulting from focused cost control actions across our operations and at corporate. The SG&A line, in particular, highlights the flexibility and operating leverage of our business. While work remained, Tom and his leadership team continue to gain traction in their efforts to drive operational excellence through our One Flowserve initiatives. They were able to increase sales, operational and cost leverage across many of the common processes in our business units. We are seeing tangible progress across many of our initiatives, including cost of quality, on-time delivery, supply chain, working capital, cost management and the front-end bidding process. The benefits of these initiatives are starting to show in our results and are improving the quality of our backlog. As we discussed after the first quarter, we anticipated challenges in our gross margins in the second quarter as we made progress shipping low margin legacy backlog, which was taken in the…

Thanks, Mark, and good morning, everyone. As Mark discussed, we are pleased with our second quarter results, with bookings of $1.21 billion essentially flat versus prior year, despite a significant headwind from the stronger dollar. Additionally, bookings were negatively impacted by the economic uncertainty in Europe, particularly in FCD. Our consolidated book-to-bill was 1.03, driven by a strong aftermarket book-to-bill of 1.07. On a year-to-date basis, we have booked nearly 2.5 billion in orders without the benefit of any large project orders. As we discussed at the end of Q1, we continued to see positive momentum building in our end markets. The level of feed and pre-feed activity has improved significantly, with levels of work in the first 6 months approaching full year 2011 levels. As Mark mentioned, when we look at the potential larger projects on the horizon, they have pushed a little bit to the right and probably will not be awarded until 2013. Turning to our year-to-date bookings by end market. We saw significant growth in the chemical and modest growth in general industries and oil and gas. Regionally, the growth has concentrated in North America and Asia-Pacific, partially offset by lower bookings into the Middle East, Africa and to a lesser extent, Europe. Both the power and water markets are down from prior year levels. In the oil and gas markets, unconventional oil, tar sands, subsea and shale continue to see a high level of CapEx. Downstream oil projects remained strong in the Middle East, Latin America and Russia. Additionally, abundant, low-cost natural gas is having a significant impact on the number of chemical project announcements and combined cycle power plants in the U.S. From a power standpoint, economic development and environmental regulations remain the primary drivers. China and India continued to utilize a broad range…

Thank you, Tom, and good morning, everyone. Before getting into the financials, I would like to spend a few minutes discussing the importance of our risk profile and the stabilizing attributes that have driven our consistency through the cycle. Our highest ever aftermarket bookings of over $500 million in the second quarter, combined with solid original equipment bookings in the absence of large projects, demonstrates the importance of our diverse end markets, broad geographic presence and our long and short cycle mix, which have been critical in lowering our risk profile and creating stability through the cycle. For example, while Europe, the Middle East and Africa have been a challenge this year, with economic instability and the effects of the debt crisis, bookings in North America and Asia-Pacific have more than offset the softness in those markets. Additionally, while our power and water markets have been down the first half of the year, they have been more than offset by the strength in the chemical, oil and gas and general industries. So as we take a look at our bookings mix in the first half of the year, we drove strong growth in our aftermarket bookings through a continued focus on our end-user strategies. The aftermarket mix increased 2% to 40% versus the first half of last year. Overall, first half bookings increased $80 million, up 3.4% or 8.1%, excluding a negative currency impact of approximately $111 million. When we look at sales for the first half of the year, the mix is comparable to last year, with 59% original equipment and 41% aftermarket. Sales increased by over $130 million, or up 6.3% over the prior year, despite $109 million of currency headwind. Turning to the financial results slide. Sales for the second quarter increased 5% year-over-year, or up 12.6%…

Thanks, Mike. Operator, we are ready to open the line for Q&A.

[Operator Instructions] And at this time, we have a question from Charlie Brady.

Can we go back to the commentary on the strength in the pre-feed and feed activity? Can you give some more granularity on where you're seeing that by end market and geography?

Yes, there's -- well, we talked a little bit about softness in the Middle East, and that's mainly around the projects that we see on the horizon, some refineries that are being built that we see coming on next year. And so you've seen a lot of the feed work in that area, feed work in the LNG. So if you look at particularly a lot of the Western E&Cs, they've been doing a tremendous amount of feed work. There's front-end work being done on the chemical, particularly in North America, where you're seeing gas as a low-cost feedstock. And then also, we talked a little bit about the power industry year-over-year and really, for the quarter, down -- it was kind of mixed. We've actually seen nuclear start to free up a little bit. And we're seeing that combined cycle on the horizon, but solar has been challenged, and they're still working their way through the coal fired. But as we look over the horizon, certainly some combined cycle opportunities, and we think that nuclear are going to come back online. So that's consistent with what you've seen. Also on the mining industry, you've seen continued feed work. That's been the case for about the last 2 years.

All right. And your commentary on the fertilizer production opportunity. Can you just go into that a little bit more? I mean, it's an area I don't think you've talked about a lot previously.

Yes, as Mark was indicating, the amount of pre-feed and feed work is significantly up on the general industries segment, of which a lot of that is the fertilizer business on a worldwide basis. So that business looks like it's really driving pretty heavily across many different regions around the world. And we would expect some good bookings going forward in that business.

Charlie, consistent with the trends we've been talking about for a while. Demand, demand for food, demand for water, demand for power, demand for hydrocarbons, they'll vary from time to time. I mean, I think one consistent theme that we've talked about is you've seen the impact to Europe, and we're not the only company. But pretty much across-the-board in our sectors, we've seen the impact of what's going on in Europe.

All right, one more I've got in the queue here. What is the new share count assumption embedded in the current guidance for 2012?

Charlie, it's Mike. Yes, I mean, I think the best way to think about it is for the year, we purchased about $433 million worth of shares. And by year-end, we'd expect that number to increase another 200, let say $240 million or so by the end of the year.

Our next question comes from Scott Graham from Jefferies. R. Scott Graham - Jefferies & Company, Inc., Research Division: Hey, I was just wondering, maybe this is a question for Mike, then one for Tom and then truthfully Mark, one for you. Mike, the cash flow profile of the company has improved towards -- 2 consecutive quarters now. And I know that there's a lot of blocking and tackling work. But is there also an aftermarket element to this where maybe the conversion of cash, that cycle is expedited a little bit and gives you a little bit more visibility on what your liquidity looks like going forward?

Actually, this is Mark. It works a little bit the other way, particularly in our seal business because we keep a lot of parts and spares in our QRCs so that we can respond very quickly so the aftermarket -- if you look at our aftermarket business, the key is the ability to be able to respond very quickly. So what you're seeing in the improvement, a lot of it is focus. There's a lot of focus. But the other thing, as Mike commented, at the beginning of the year, we talked about a focus around our past due backlog, which is distinct from legacy and how we were going to bring that down. And we've had good success. That will correlate to working capital and the utilization of working capital. So it's really been around a lot of the operational improvement. We still have work to do on the working capital. But that's driven some of the cash conversion. R. Scott Graham - Jefferies & Company, Inc., Research Division: As far -- so Mark, maybe they'll just stay with you. The legacy backlog just -- I guess, it's frustrating from an outsider standpoint that this thing, this keeps slipping into deeper and deeper quarters. Now you're signaling that possibly even into the fourth quarter. Could you tell us why that is exactly?

Yes, I mean, this is the same thing. It's the other side of what we saw in 2009 and 2010, when the 2008 very high-priced backlog lived with us for a period of time. That's just the way our long cycle business works. And we commented last year that some of the projects were going to live into 2012. I think the key is you’ve seen the growth in our aftermarket business and being able to offset that; the growth in our short cycle business. It's the way our business works. And it's also why you didn't see tremendous volatility in earnings through the cycle because you have this lag effect. So as Mike commented, I mean, one of the particular projects, we're very -- it's very strategic. We're very happy about it, sole sourced in the western region of Saudi Arabia. We will get the kind of aftermarket capture that you are now seeing embedded in our $508 million of bookings. But the fact is these things, you work through them; they're long cycle project. So we anticipated it. We'll work through them. Sometimes these things do push if the customer is not ready. But for the most part, we'll have a lot of this cleared from where we were at the beginning of the year, at the end of the third quarter. In the fourth quarter, we typically have a lot of other strengths in our business that will tend to offset that. And as we set up for 2013, we will get the benefit from really moving out of the cycle that we saw in 2010, 2011. We talked about some of the additional bidding activity that we see in 2013 and some projects. We'll see some of the benefit from that next year, but it will carry on. That will be long cycle, as well. So that benefit will stay with us. Driving our initiatives, as we talked about around an improvement in our gross margin, improvement in our operating margins, focus on leverage. So this is the way we kind of cycle through in our business. R. Scott Graham - Jefferies & Company, Inc., Research Division: Okay. So let me just try to paraphrase what you said on the incremental. So what we thought was going to be kind of a wrap-up in the third quarter of the legacy shipments, essentially gets pushed into the fourth quarter based on customer push backs of deliveries. Is that fair?

You can have -- the customers, you can -- look, one of the things on these big projects we've talked about before is we have to wait on a motor. And if the motor is slow on delivery, then that can push us. But for the most part, we see our way through. Where we were at the beginning of the year, we see a lot of this getting up by the third quarter, which is what we anticipated. If some carries over to the fourth quarter, that can happen overall in our business. But we'll move past the cycle this year and basically get into the environment we've been in since the last half of 2011 starting in 2013. R. Scott Graham - Jefferies & Company, Inc., Research Division: All right, fair enough. The other question I had was for Tom. Tom, your work across the segments. I'm just kind of wondering, I asked this question last quarter but now we've got a little bit more runway here with you with what you're doing, a little bit more time to implement. What are the big things that you are focusing on, on the cost side right now, Tom?

Well, I mean, everything from our perspective starts on the proposal stage. So we're putting a lot of effort into the proposal and in terms of the set up if the scope on the job, the set up of the terms, the costing, a lot more advanced procurement resources we put on that aspect, as well as good cash flow management, as we look at our cash flow strategies in the proposal space. So I would say that's one aspect. We continue to focus on the same things that we've been focusing on in the last several years, which are gross margin. There, we take a lot of effort in terms of low-cost sourcing, the lean, the Six Sigma efforts, the throughput through the facilities. We have good line of sight on areas that we want to fix in several of our facilities, and we have teams on those. I would say the other 2 items are items we talked about before, which is the base, which is the on-time delivery. So a significant amount of focus on supplier on-time delivery, as well as individual unit on-time delivery with our initiatives. We spend a lot of time on quality and quantity of documentation to get at the working capital, as well as try to get at first-pass yields through the business so that we improve the overall efficiency and throughput through the businesses. So I would say a lot of the basics we continue to drive. We just have, I would say, a more rigorous program for driving those initiatives.

Scott, the general theme that was in our comments and what we're focused on, we are very focused on what we have in our 4 walls and being able to even drive margin improvement there. We think we have opportunity there. If you think about it, we came through a high-price cycle in '07 and '08. We spent a lot of time realigning what I'd call the front end of our business in '09, '10 and '11 on the aftermarket side, integrating pumps and seals. And now this is a step around really driving the operations engine of this business to carry us into this next cycle.

Our next question comes from Kevin Maczka. Kevin R. Maczka - BB&T Capital Markets, Research Division: First question on the demand side. It sounds like you're optimistic there but you did have some commentary about short cycle moderating and some mega project pushouts. So 2 questions. I guess on the short-cycle side, has that stabilized at this point? Any moderation that you've seen? And on the mega project pushout, if that's macro-related, what is it from your customer conversations that gives you confidence that, that will, in fact -- those bids will be the let in 2013 and not just pushed out even further if things remain tough?

Okay. Well, a couple of things. On the short cycle, moderating doesn't mean going down. Moderating means you don't see, for example, the growth rates you saw this time last year in FCD. They were up almost 30% in the bookings in the quarter. A lot of that overlay around that moderation is Europe. You are just seeing the impact of Europe across the board on our sectors. That's what's driving the moderation. But moderation still means growth. I think the thing on the -- what on the long cycle in the projects, we made these comments in the beginning of 2009. We said, "Look, there's been a lot of investment made in these projects already. Feed work and pre-feed work, there's a tremendous amount of investment." So as it did then, we have confidence that they'll come online, but you do see it. They can't push out of couple of quarters, especially when the world pauses to see what happens in Europe. What gives us confidence that they'll come on is one, the investment that's been made; but more important, the need for these projects. They have strategic value. So you talk about the chemical facility in the Middle East. They have a strategic focus on making sure that they're vertically integrated across their feedstocks and putting more refined output out into the market as opposed to just basic crude. Those are strategic drivers. You look in, for example, in Latin America. Some of what you've seen is the impact of elections in Mexico and then there's a new leader at Petrobras. It doesn't mean they aren't going to invest going forward because their economies or their companies are highly dependent on monetizing these natural resources, but an election will affect the timing of some of these things. You know they're coming back online because they need them basically for their economy, for independence, for their population, same thing with power. So that's what gives us confidence. It's the same thing that gave us confidence that projects would come through when we were sitting there at the end of 2008 and 2009. It's just we recognize that they can push a couple of quarters. Kevin R. Maczka - BB&T Capital Markets, Research Division: Got it. And then, Mark, environmental regs is another area that we haven't talked as much about. But you mentioned it a couple times in your slides today in the oil and gas and the power space. Can you just maybe give a little more color there? Are there some potential real needle movers here? And what kind of compliance timing are we talking about in a couple of instances?

Well, I mean, there is -- there are always needle movers. But if you look at how diversified we are across, for example, the hydrocarbon, oil and gas business, LNG has been certainly a needle mover. But in and of itself, it's -- since we're not highly concentrated necessarily in one area, it'll move, but it's not significant. That's the opportunity of being diversified. In terms of -- if I understand, on the regulatory on the power, the coal-fired plants in the United States have been hung up for quite a while. And now with -- although natural gas has increased in price with, that as a relative low-cost feedstock and viewed as an abundant resource, people are tilting more towards combined cycle. But I think when we look at it, we don't expect the entire power industry in the United States to go to combined cycle because if gas were to go back up to high levels, then they'll be caught on the other side. So there is a view globally that they're going to stay diversified in their power sources. I mean, we fundamental believe nuclear is going to remain 20% of the global supply of power. But you do have regulatory issues. Also certainly in the United States, and to a certain degree, in Europe as well, we've seen the nuclear industry go through what I'd call a re-evaluation mode. But they're also starting to invest again. So it's -- we'll always have these things kind of coming up overall in our business. But we remain optimistic on the power just because of demand with the urban growth and just the requirements around the world and the same thing on the hydrocarbons.

Our next question comes from Mike Halloran. Michael Halloran - Robert W. Baird & Co. Incorporated, Research Division: So some thoughts on lead times, how they're progressing from here. I know you've got some moving pieces on the lead time side, but maybe you can try to frame it more in terms of how demand is impacting the lead times and your selectivity on projects as it stands here. And then also a little bit of commentary on the utilization levels you're seeing in your plans and try to compare that to the industry.

Yes, I may not have heard the last one; somebody will tell me. But lead times, you've see them come in. I mean, an E&C always wants to bring those in because time is money. And so part of what Tom and his organization are focused on is making sure that we can drive the efficiency to respond to the lead times. So when you look at how they evaluate us bidding on a project, lead time is certainly one of the things they consider. So they've come in. Where we saw lead times really gap out was in '07 and '08 when the entire supply base was getting constrained. And the E&Cs recognized that they were going to have to flex out on lead times. Michael Halloran - Robert W. Baird & Co. Incorporated, Research Division: And the second part of the question was just utilization levels, how the trending in your facilities and then maybe try to give a comparison.

Yes -- no, good question. I mean, Mike, we talked about -- look, I'll give you an industry perspective. In '09 and '10, you had capacity that came on that was planned in '07 and '08, and there was capacity that was certainly chasing price at that point in time. As part of -- as we look over the horizon and see these project opportunities so do our very capable competitors, and they will start to rationalize. So capacity has started getting incrementally utilized in our business. And as these projects come online, it'll start to get utilized and that's when price will start to rationalize that capacity.

Our next question comes from Robert Barry from UBS.

I just wanted to clarify some of the commentary around the margins. I was under the impression that we would see a slow but somewhat steady improvement in margins from 2Q to 3Q to 4Q. And it sounds like now maybe 3Q will step back but then 4Q will rebound perhaps more dramatically. Is that the right cadence, Mike, interpreting that?

Well, I think you -- there's 3 factors that -- around earnings that Mike talked about relative to Q3. But keep in mind, around our third quarter typically, we do have a seasonal element to that. Europe is on vacation. If Ramadan falls within that period of time, typically, if you looked at our absorption, fixed cost absorption, Q1 tended to be our lowest historically and Q3 -- it was -- yes, Q3 was our second lowest. So there's always been that element around the margin profile in the business. In addition to that, it's pushing through some of this legacy backlog as well that will impact margins. Now what we'll do to certainly offset that in Q3, Q4, all next year, is to continue to drive our margin improvement initiatives. I mean, look at what's happened in IPD. So some of them, I would say, are around legacy backlog and typical seasonality. But there are things that we'll focus on within our control: costs, improving the IPD platform that we've talked about and operational enhancements, a lot of things that we're going to work on. But I think we just want to give you a general sense that remember, the seasonal element around Q3, also that we're working through this cycle and with some of the legacy backlog, as you look at our margin profile. But it's certainly important to us.

Just to clarify one of the earlier questions, is the legacy backlog moving through the P&L at the pace you anticipated at the beginning of the year, or has that pace changed?

Yes, it's pretty much as expected. And we talked about last year, and we said "Look, we're going to be living with the down cycle though a good part of 2012. It's just the way our business works." Like I made the comment earlier, because of the lead times, earlier to Mike's question, earlier, the lead times back in '08, we were able to live with which was very high-priced backlog in -- for about 2 years. And so this is the offsetting impact as we work through the cycle as well. But we had anticipated. The other comment we made in the beginning of the year was around our past due. And we've made the progress we anticipated as well and brought that down.

I guess just finally, I wanted to ask about oil and how that's changed conversations with customers. I mean, through the quarter, both WTI and Brent came off pretty significantly. I mean, it's rebounded recently. But at these levels and considering the volatility, has that changed conversations at all with customers?

No.

Maybe about 2013 CapEx?

No. When we go out and talk to them, they actually, in the Middle East, they set budgets at a lower expectation rate around Brent in terms of the way they look at things. I mean, if there is a sustained drop that is viewed to sustain over a long period of time, well below the levels that we have right now, then they may evaluate the projects. But to date, we have not seen them start to question their investment because of the movement. I mean, they look way past the spot price of oil.

Our next question comes from Hamzah Mazari from Credit Suisse. Hamzah Mazari - Crédit Suisse AG, Research Division: The first question is just on how you folks are thinking about M&A and your appetite for acquisitions. Given your buyback, given some of the stuff you're doing on the balance sheet, and also, given the new CEO structure that you've put in place.

Okay. Well, I mean, I think the way we generally look at cash deployment is what is the best return for our shareholders in terms of how we deploy cash. So if you think, for example, a highlight on the capital structure, it was really around -- as we moved through the cycle and saw the durability of our aftermarket business and cash flow generation, it gave us a lot of confidence in going ahead and taking up our leverage profile. The result of that was that we were going to in a sense from levering up precipitate some cash. When we looked at the deployment of that cash, we said, "Look, relative valuation of our company, that's a good investment." So that drove the $1 billion share repurchase program. As we look at M&A, we look at similarly. We're always going to look at the alternatives of how we deploy cash: CapEx, dividends, share repurchases and inorganic opportunities in terms of returns to our shareholders. As we look at the pipeline and M&A, one of the things we talked about, because we have a broad geographic scope and quite a few products in our portfolio, what we want to do is focus on bolt-ons. Bolt-ons are -- have to have good strategic fit, and that is what you've seen, for example, on Valbart and Lawrence that we can leverage our sales organization, drive through our aftermarket capabilities. So in terms of strategic fit in our space, we will also focus on the impact to integration. And I think a lot of that correlates to our new COO structure, driving a lot of operational initiatives. And what we want to make sure is that those stay a priority overall in our business. And then finally, we'll look and determine how we finance it. But it's really going to start in terms of what is going to be the cash-on-cash return of the investments we make. We recognize that we want to continue to grow the business as well. So we think with the flexibility in our capital structure, we can really look to grow our business, also invest in our business, both in CapEx in terms of our share count as well, and really drive returns to our shareholders. So that's the way we think about it. Hamzah Mazari - Crédit Suisse AG, Research Division: That makes sense. And then just a question on the legacy backlog. You guys spoke of that being a margin drag, 100 bps, 200 bps, maybe. Could you maybe comment on how we should think about the difference in margin profile on that legacy versus the past-due backlog? I assume not all past due backlog is low margin. Maybe if you could touch on how we should think about that.

That's fair. I mean, not all past due is low margin. And so as you think about it, past due correlates more towards some of the working capital, some of the things -- the impacts you've seen on inventory in the business. Now having said that, we've always talked about time is money. So to the extent something becomes past due, the margin profile does change, and typically, not for the positive. So there is a related element of that. But -- and the way to think about the legacy backlog, Hamzah, if -- we've talked about this. On our long cycle business, which has, historically, been 20% of our business, think back about '07 and '08. And also consider that on these big, big projects, 40% to 50% of that project is something we buy from other companies, a big driver, a big motor. And we can't drive big margins on those buyouts, as we call them, to our customers. They just source them directly. But what you saw in '07, '08, there was so much competition for capacity in the industry we were actually able to get good decent margins on the whole project itself. You roll forward to back to what we saw in 2010 and 2011, and people were looking to cover their absorption, cover their variable cost, which means you had fairly low gross margin bids out there in the business. Now as things have started to kind of rationalize a little bit in late 2011, 2012, what you see is you can get good margin on the equipment you manufacture and get margin on your engineering capabilities and your ability to assemble, test, deliver, design and really, ultimately, support it. But you're not going to be able to command very high margins on the buyouts of these business. So what we're seeing is the market is starting to move back to more normal levels and typically, what you'll see is it will undershoot in the down cycle and it will overshoot if capacity gets real tight. Hamzah Mazari - Crédit Suisse AG, Research Division: That makes sense. And just a last one for me, just for Tom Pajonas, just a clarification. On the Flow Control business, is the margin coming in lower all mix, or did you see any disruption from you moving to the COO role, or is that just all mix and you expect margin to come back?

Yes, I'll take the latter part of that question first. I mean, the management team there is very capable of continuing to execute and expanding the business going forward. So I'm very confident in the management team there. The gross margin issue had a lot to do with the mix shift to the original equipment. Also, it had to do with -- we took some shipments that were lower margin strategically in the oil and gas area, particularly in the Middle East in order to build up the backlog there, get the capacity for some of our facilities in Europe and to begin to look at the aftermarket business there. So I would say we're aware when we took those jobs that, that gross margin was going to flow through. And I'm very confident going forward in terms of the gross margin of that business picking up in future quarters.

Hamzah, let me just clarify just one thing, I -- somehow, we've gotten the notion here that legacy backlog was -- is bad and it is lower margin. But keep in mind this is what will continue to feed our aftermarket business. So part of what you've seen us to support us through the downturn and provide good earnings, stability and growth in our business is our aftermarket. And part of this -- a lot of this legacy backlog is directly related to feeding that aftermarket business in future periods.

Our next question comes from William Bremer from Maxim Group.

Question, bookings. Quite impressive on your bookings given the fact that you had really no large -- or you called out really no large projects. Can you give us a sense of the current pricing that's in those bookings right now because it is much, as you say, shorter cycle?

Yes, I think in general because a lot of the processes that Tom has talked about and really what we see on the horizon in terms of projects, the quality of our backlog improved. And in that, there's a number -- price is certainly an element of that. You also, as we look at flow-through and cycle times, quality, on-time delivery, all those aspects of us gives us confidence that what we're putting in backlog has an improving margin profile.

Okay. Many of my questions have been answered already. I want to go right to the guidance. Mike called out 100 bps to 200 bps year-over-year. Is that year-over-year on an adjusted basis?

Yes, that's right. Q3 versus Q3 net last year.

Okay, on an adjusted basis, though?

Yes, in terms some of the realignment activities and everything we had, yes. It's just -- if you look at the business in terms of backlog flowing through and backlog flowing through, it's 100 bps to 200 bps.

Right, right. And you made the comment that it might be a tough hurdle on the bottom line so to take that into consideration. The other question I have is on the FCD in terms of the margin degradation there a little bit. I know you sort of spoke about a little bit of the mix shift there. But has there been any legacy projects or, say, slow- or no-growth margin projects in that particular segment? I thought the majority of it was in EPD and IPD?

Yes, that's fair. But what Tom commented, they've started to move into particularly in the Middle East, some of these big projects similar to what EPD did. And that's part of what you saw in this quarter. But keep in mind, we opened a big aftermarket facility there in the first part of this year. So FCD is starting to leverage some of the capabilities that EPD has had for many years in terms of driving their aftermarket business. Keep in mind, if you think of the evolution of aftermarket, it was typically our heritage seal business that drove strong aftermarket growth, then the pump business, you saw increases there. Now with this One Flowserve, Tom is starting to drive some of the same capabilities across our valve division, which typically had a relatively low aftermarket retention. So it's part of the projects. And the other thing was, as you look at in terms of our capabilities -- broad capabilities, on some of these big projects, we were able to get our pump seals and valves on them.

Our next question comes from Jamie Sullivan from RBC Capital Markets.

Just to clarify the last question on margins. You have the 100 to 200 basis point headwind, but it doesn't necessarily mean the margins will be down year-over-year. Looking at 2Q, you had the headwind, but margins weren't down. Is that the way to think about it?

Well, we've got the headwind. Like you saw on the second quarter, we are able to offset it some with better flow through and operational improvement and increase in aftermarket. All we're trying to do is isolate the impact of the business that's come through that was booked in the downturn for aftermarket business going forward. And sometimes, it was to load the facilities. There's -- the other things will continue to drive margin improvement overall in the business: cost controls, better flow through and the gross margin line.

Right, okay. And on the -- you mentioned the legacy backlog and the aftermarket opportunity there. Can you talk about how the aftermarket capture rate maybe has progressed on backlog today versus 3 or 5 years ago?

Well, it's certainly a component of the growth. I mean, if you go back and look at our CAGR growth rate in the aftermarket business over the last 5, 6 years, it's been very, very strong. It has been an amount that's well over the net incremental installed base that's going in around the world. So part of that is better capture rate of the installed base we put in because as you look at customers out there, the equipment’s becoming increasingly complex. And so oftentimes, they want the OEM to service it. You also have the other dynamics that a lot of their capability is for repair to the customers, which is probably our biggest opportunity. You're seeing the rotation in retirement there or redeployment oftentimes to other parts of the facility. So we've certainly seen better capture rate. But you've also seen the benefit of expanded QRC base, where we're going in and taking aftermarket capabilities from the customer or, to a certain degree, some local machine shops. And also, the benefit of our ISG strategy that's really driven around operating optimization for the facility. So there's a number of things. But keep in mind, as you look at our industry, if you just put installed base in, our aftermarket would not be going at the rate it was because there's just not that much incremental installed base around the world on an annual basis.

That's helpful. And then one last quick one. We've heard some mixed commentary from companies on China. Just curious if you could talk about what you're seeing in the region, I guess, more on the shorter cycle businesses across the segments.

Well, we -- that was one of the areas of growth overall in business and part of being diversified. I mean, it depends on the areas. Oftentimes, on the consumer base, you've certainly seen pressure in China. But a lot of this is infrastructure. And they are continuing to invest in the infrastructure of the business. You look beyond -- behind the spend in China, you still have the issue where people are moving to major cities and require more power. You still have more cars on the road for -- on the hydrocarbon side. So a lot of the things that create this durable demand overall in China play out overall in our business. Now if you look at any kind of niche areas in the industrial space, certainly, in the consumer space, areas like that, then the relative growth does have an impact. And also, keep in mind, China has talked about going from growth rate to 9% to 6% overall in the business. A lot of that on the margin is going to be areas that don't impact our business. It's going to be consumer or some, what I'd call, very, very short cycle. In a lot of our short cycle business, keep in mind, also is replacement. So these facilities need to continue to operate. I'd tell you the same thing in Europe, is while it does represent approximately 20% of our business, that's why you haven't seen it completely go away is because a lot of this is tied to facilities that are currently operating.

Our next question comes from Brian Konigsberg from Vertical Research.

I apologize if this was asked. I jumped on a little bit late. But just in regard to FX, you guys have been hit a bit harder than I think, really almost any industrial that I have come across in the second quarter. Obviously, everyone is seeing headwinds, but yours is fairly exaggerated. Can you just kind of discuss how that will flow through? I understand -- from what I understand, it's kind of hedging against the mismatch between products sold -- or produced in the European region, but maybe sold in different currencies? And I would assume that they would actually result in an improved margin profile later down the line. But maybe can you just walk through that and talk about what you would anticipate that margin improvement to be, if you can, and when you would anticipate that benefit to flow through, that is offsetting the headwinds that you're seeing in the other income line in Q2?

Right. Well, I mean, on your general comment around industrials, an industrial that has 70% of the business outside of the United States probably are seeing a similar impact to currency. The one thing -- I don't know specifically their hedging strategies. But the one thing that may be different is we do hedge our cash flows in our business. We think cash earnings over the period of time is ultimately the right thing. So if we have a cost, not on every project, but in a meaningful amount, if we have a cost that’s denominated in euros and a contract that's denominated in dollars, we want to lock in the economics. So that may be something you're seeing different. But the converse of that would have been last year, in the first part of the year where we had earnings below the line related to our marks as well. Generally around the margin profile, a negative mark will tend to indicate margin improvement in future periods, depending on when that's ultimately delivered. Keep in mind, the mark is done quarterly. So if you put the notional -- it's really sitting on backlog. If you put the notional amount on our order that's in backlog that stays there for 4 quarters, you're marking that notional every quarter that comes through. But ultimately, what that means is if the euro has weakened on a dollar-denominated contract, you'll get margin expansion and you'll take the negative impact below the line typically in a prior period.

Right. So based on the pressure that you've seen in Q1 and Q2 and likely, you'll see in Q3, do you have a sense of what kind of margin expansion should follow based on the marks you've taken?

Well, one way to help you out is there is -- I think in our disclosure, there's a portion of the mark that's related to our hedges. And if you just look at what lead times overall in the projects, the 3 to 6 quarters, you would take that mark, if sustained, and smooth that over those periods. That's probably the best way to estimate it. And that would be your margin impact. So if you, for example, had a $6 million mark and nothing else changed over in our business, and it was related to hedges, you'd look to take that maybe incrementally evenly over the next 4 to 6 quarters.

Got you. And separately, yesterday, there was a fairly large acquisition announced within the E&C space. I'm just curious, as far as your relationships with the 2 that are considering combining, how does that affect you? Are you kind of a preferred supplier to one of the 2, to both? Do you anticipate more opportunities, less opportunity associated with that deal?

I don't think it is going to tip the needle either away, I mean -- and we'll get more of the details around it. But generally, on these big, big projects, we work with multiple E&C firms. Now clearly, some we work more closely with than others. But we don't anticipate that's going to impact our business.

Our next question comes from John Moore from CL King. John R. Moore - CL King & Associates, Inc.: Two questions on the guidance to start here. First of all, with the foreign currency being an additional $0.50 headwind, that offset by the $0.30 from share repurchases and I guess, $0.05 from corporate -- the corporate benefit this quarter, it looks like you're basically absorbing about $0.15 here in the back half of the year. And it sounds like the top line might be even a little bit slower than you expected. So I'm just wondering if there are 1 or 2 items you can point to operationally that are performing better than you had originally anticipated.

Well, a couple things. We haven't changed the indication around our top line. We had a 5% to 7% range. We've laid that out, I think, in earlier periods and it hasn't changed at this point in time. But I think what you do see is we have been -- we've been able to offset this, and some of it is the traction that Tom is getting overall in the business and the focus on costs as well. But if you think about it, as you look at the guidance for the year, what clearly, you can see from our guidance this quarter, going from $0.50 to $1, is the significant impact that volatility and currencies can have in our business. That's something we certainly can't control. So what we do is focus on what we can control and driving the improvement. John R. Moore - CL King & Associates, Inc.: Okay, I got it. I guess the 5% to 7% range that it's -- I'm interested to hear that you're able to still achieve that with the foreign currency headwind. Have you actually -- I guess, can you talk about it organically? Have you actually raised your organic revenue growth forecast for the year?

No, I mean, the organic number is what we give you on the constant currency. And so you can kind of monitor that. Keep in mind, as we go through the year, on a year-over-year compare, Q2 would have been one of our toughest, but Q3 is as well. I think the euro was still relatively strong, or the dollar was relatively weak to other currencies in the third quarter. But you saw that abate significantly because the dollar started strengthening in Q4. So at these levels, Q3 is still a tough compare from a currency standpoint, but that impact starts abating in the fourth quarter. John R. Moore - CL King & Associates, Inc.: Okay, got it. Just final question then. The IPD orders this quarter, I thought those were actually pretty strong, given the -- what's going on here in the global economy and that does seem to be your shorter cycle business and a little bit more through distribution. So just curious if there's a specific trend that's benefiting orders there? And I guess what I'm thinking of is the chemical industry and the benefit from, I guess, the shale gas here in the U.S.

I think they will certainly benefit from some of the trends overall that you're seeing in what we'd call the shorter cycle business, also benefiting from some of improvements they've driven. I mean, bottom line is, they're taking better care of their customers, and the customers are responding. But my comment around the short cycle growth, around moderation, I'll remind again, it doesn't mean no growth. It just means, for example, on FCD, they had a, I think, 25% or 30% constant currency growth in the second quarter of last year. Those are tough compares. So we will go back to what we said 4 or 5 years ago, don't read too much into just any one quarter. Look at overall trends. But what you are seeing is the short cycle business grew nicely in the early part of last year. That's moderating some but it is still growth. And what we see next on the horizon is our longer cycle business.

Our next question comes from David Rose from Wedbush Securities.

I'll just go with 2 quick ones, and we can follow up later on. I was wondering if you can talk a little bit about the SG&A, how we should think about it. I know we talked about that it should -- your long-term goal is 18%. Is there a sequential cost containment expectation that you might have as we go into Q3? Can you see that go down versus Q2 in any of the specific divisions?

Well, take along quarter-by-quarter, keep in mind that Q3, as I mentioned earlier, typically is our second lowest absorption quarter. And that will impact all fixed costs, including SG&A. But let's really look longer-term. What we want to do over the next 2 years is drive this down towards 18% in our business. A lot of that comes from growing our business at a rate that's quicker than you're growing your SG&A. And also, we need to take advantage of some of our One Flowserve initiatives as well. You've seen us over the last couple years hold very, very tight on our corporate cost; continue to do that as well. So it's a lot of things that we're driving, but it's really more around driving leverage in our business over the next couple years. That's part of our margin improvement profile. So as you kind of take a step back and look at margins, improvement in the IPD, they had very good cost leverage. But we see opportunity for them to grow their gross margin levels. If you can look over history, they've been higher than they were at this point in time; grow that as well. Continue to grow our aftermarket business. Take advantage of the opportunity of some of the long cycle business and leverage our SG&A. All those are interrelated. You can over-tilt on one to the detriment of the others. So we manage them very systematically across the overall business.

Okay, that's helpful. And then really trying to get a better idea on gross margins, as you look into better bid discipline, as you discussed, and that's how we should start look at the backlog, are there any metrics you can provide to -- and give us some comparisons year-over-year on bid discipline? How should we look at that?

Well, I mean, I think Tom's comments around on-time delivery. I think that's going to correlate to past due backlog, and that's going to correlate to working capital, and that's going to correlate to margins as well. So I think just the commentary on how we're making improvement on our operational initiatives, coupled with our fixed cost leverage, and then our general commentary overall in the market environment are really the best indicators for what our margin profile can be looking forward. We'll also try to give you as much color as we can over the relatively short term on the impact of maybe some of these legacy backlog projects. But part of that is why we put these targets out over a multiple-year period is, as I made the comment earlier, you can drive margins certainly very, very, very short term, but impact your overall margin profile long term. So we're always striking the balance there.

Okay. And then, I'm sorry, lastly, you had once mentioned fee-based from your aftermarket. You provided a number of customers and dollar amount. Do you have some sort of comparison for us on fee-based activity from your aftermarket business?

Well, I think the number we provided, if I recall correctly, it was -- we had these alliance agreements, about 180 of them. And that number does continue to increase. But going back to my comments originally and my remarks is we still -- even though you can have a fee-based or a contract, we must earn the right to serve our customers every day. And so we don't get overconfident in the fee-based. What that does indicate, though, and we're seeing them increase is how customers move strategically around total cost of ownership and lifecycle cost. And if you think about where this industry was 10, 15 years ago, there was the delivery and the commissioning of the facility and then really focused on maybe parts, service and repair. Increasingly, customers now are thinking about the operation of their facility over 5 to 10 years, and that's where we're starting to pick up some of these fee-based opportunities.

This time, we have a question from Charlie Brady.

Sorry if I missed it but can you give us what the fully diluted share count was at June 30?

Say again?

What were the total fully -- what was the fully diluted share count at the end of the quarter on June 30?

Shares outstanding on the face of the Q is 51.129. The weighted average was 54.266.

The 51.129, that's of July 23 or so. I guess what I'm trying to get to is there were share repurchases that happened subsequent to June 30 that aren’t reflected -- or are reflected in that.

That's correct.

That's correct.

So do you have what the share count was at the end of the actual second quarter?

That's the one he just gave you that was on the face of the document. I mean, you've got a difference between what was the average share count during the quarter because it makes a difference if you buy them in the first day of the quarter and the last day of the quarter. But that amount on the face of the Q is what will carry forward starting on July 1 into the back half of the year.

Yes, okay. I just want to make sure there wasn't some share repurchase happened in that 23 days that skewed the number. That's what I was trying to get to, really.

Yes so in July?

Yes.

I mean, we're continuing with them but we'll disclose that as we close out the quarter. I think what Mike talked about is relative to where we were in the program in the end of the quarter, this being June 30. We expected another 200 million to 240 million during the balance of the year.

Okay. And on the corporate -- discrete corporate items, there was a benefit. What was -- what exactly was that?

Well, I mean, it's something -- it was just resolution of a matter around accruals. I mean it was a legal matter that we resolved over a period of time, something we've been accruing for systematically over the last couple of years. So it's part of our business. But it was related to a legal accrual.

Our next question comes from Stewart Scharf. Stewart Scharf - S&P Equity Research: Most of my questions have been answered. But just looking at the DSO and inventory turns and your targets, and based on your sensitivity analysis, will that translate into, say, $200 million in cash flow if you got to 65 days and another $350 million to $500 million for the inventory turns based on 4x and 4.5x?

Yes, Stewart. Mike. Yes, I think in the Q, we disclosed that every day is worth about $13 million now, and so we're at 80, around 80, 81 days. So if we get down to mid 60s, that's worth about $130 million or so to monetize over that period of time. And then by increasing our turns, we've got some potential benefit there, too. And another roughly, say, another $50 million to $100 million or so of monetization there potential in all. Stewart Scharf - S&P Equity Research: And what's the timeframe for that?

I think what we said is that the DSO target is a 12- to 18-month period and the turns are 18- to 24-month period.

Thank you. This concludes the time we have for our question-and-answer session. I'll now turn it back to Mr. Mullin.

Thank you, operator, and thank you, all, for joining today.

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.