福斯 (FLS) 2007 Q1 法說會逐字稿

At this time I would like to welcome everyone to the Flowserve's Q1 earning conference call. (OPERATOR INSTRUCTIONS) Thank you.

I will now turn the call over to Mr. Nagle. Sir, you may begin.

Thank you for joining us. Welcome to the Q1 2007 Flowserve investor conference call. Today's call is being webcast with our earnings presentation via our website at www.Flowserve.com. Just click on the Investor relations tab to access the webcast. Before we get started today I wanted to make one technical note. For those of you who have accessed today's call through our dial-in phone number and also wish to follow along with earning's presentation slides via our website, please click on the "Click here to listen via phone" icon at the bottom of the events details page. I'd also like to note that our webcasts will be posted on our website for replay approximately two hours following the end of the call. The replay will remain on the site on demand for the next few months.

Joining us today are Lew Kling, President and CEO of Flowserve; Chief Financial Officer, Mark Blinn; and Chief Accounting Officer, Dick Guiltinan. Following our commentary, we'll begin the Q&A session. Regarding any forward-looking statements, I'll refer you to yesterday's earnings release and earnings presentation for Flowserve's Safe Harbor statement on this topic. The Safe Harbor statement is also outlined in our 10-Q filed yesterday and our 10-K filing. All of this information can be found on Flowserve's website under the Investor Relations section. I encourage you to read these statements carefully with respect to our conference call this morning. The information in this conference call including the initial statements by management, plus their answers to questions related in any way to projections or their forward-looking statements are subject to Flowserve's Safe Harbor statements. Now I would like to turn it over to Lew Kling to begin the formal presentation.

Thanks, Zac, and good morning. I'm very pleased to report a very strong first quarter for Flowserve. We met or exceeded the goals we set out to achieve, and I believe we have positioned ourselves well to meet our financial targets for the rest of the year.

Slide 2 highlights just some of the significant results of the first quarter. And you will note we set a number of new records for the Company. Earnings per share were up 84% versus last year to $0.59. This represents a record first quarter EPS for the Company and a growth rate that substantially outpaced our strong sales growth of 23%. During the quarter, we also achieved the highest level of quarterly bookings ever for the Company, $1.1 billion, which included a very large number of major pump project wins. This represents a 24% increase year over year. Operating margin improved substantially in the quarter to 8.4% from 6.3% in the first quarter of 2006, up 210 basis points. This reflects the good traction we're getting in our operational excellence initiatives and strong absorption of fixed costs.

As I discussed earlier, sales are up significantly in the first quarter to $803 million or 23%, reflecting strong conversion of existing backlog to sales, and a strong end user, after-market capture rate. We also made significant progress on our SG&A front in the first quarter due to the solid traction we saw on our SG&A reduction initiatives and the leverage we gained on fixed costs on higher sales. As a result, SG&A as a percentage of sales was reduced 230 basis points from 25.3%, up from 27 -- to 27.6% in the first quarter of 2006. Our end markets continue to show strength in the first quarter, and we continued to invest in the growth of the business in strategic locations, most notably capacity additions in Bangalore, and Coimbatore, India, Taxcala, Mexico, and Suzhou, China.

We also invested heavily in the global, quick response center expansion building on our strategy of continuing to be close to our customers to provide them with the products and solutions they need when they need them, and whenever they need them. Lastly, we are affirming our previously announced 2007 financial targets of both sales between $3.4 billion, and $3.6 billion, and operating margin improvement between 200 to 300 basis points.

Turning to our P&L, we are especially proud of our global team's ability to drive net income and EPS growth rates significantly higher than the already-strong sales growth rate in the first quarter. With our quarterly sales growth approximately 23%, our operating income growth was 64%, our net income growth was almost 81%, and our diluted earnings per share growth was over 84%. This demonstrates our ongoing focus and success of our operation excellence and SG&A cost reduction programs as well as the strong leverage we can achieve on very robust sales. As I outlined in the highlights section of the presentation, our bookings growth continues to be strong. In the first quarter, we topped the $1 billion quarterly bookings mark for the first time in the history of Flowserve.

This $1 billion quarterly bookings level highlighted our seventh consecutive quarter of double digits organic bookings for the Company. This strong trend in bookings growth for the past several quarters is due to the significant number of large project orders which should be the fuel to drive significant, higher margin after market business in the future. The strength in orders in the first quarter was primarily driven by the very large number of project wins in our pump division, mainly in the oil and gas and chemical markets, especially in North America, China, and the Middle East. Sales continued to accelerate in the first quarter as we converted existing backlog and focused on our strategy of strong, after-market capture. Sales were up 23% versus 2006, the highest growth rate in nine quarters.

Slide 6 breaks down the bookings performance by industry and highlights some of the key dynamics we're seeing in the marketplace. In the first quarter, we saw strong, positive growth across all industries with particular strength in the oil and gas and chemical sectors, each growing over 30%. The strength in oil and gas was driven primarily by solid, Middle East, upstream demand, increased investment and refining capacity, and continued growth in the expansion in the North American and Chinese markets. The high growth rates achieved in the chemical industry were largely driven by increased in the chemical industry were largely driven by increased investment in new capacity in the Asia and India markets.

The power and water industries continue to be solid markets for Flowserve, as critical infrastructure requirements continue to require new and upgraded facilities. There are also an increase in planning for new nuclear power facilities. General industry was also a steady growth market force in the first quarter, driven by a relative broad spectrum of submarkets with strong growth from mining and district heating.

Looking at our sales by region, the first quarter saw strong growth across every major market, with 20% or greater growth in North America, Europe, Middle East, and Africa, and Asia-Pacific. We also saw solid growth in Latin America. In North America, growth was virtually across the board, driven by needs in power, refining capacity expansion, refurbishment of water infrastructure, and an increase in chemical production. Canada also experienced good growth driven by tar sales investments. And in Asia, the need for continued development of infrastructure in China and India remain primary drivers for investment, particularly in the power and water industries. The Australian markets also showed relative strength in energy and mining. And in Latin America, we also saw steady growth markets as Mexico's economy improves, mining investments remain solid, and investments in oil and gas improve within the national oil companies. We continue to position ourselves with a global footprint for driving profitable growth particularly in high-quality, low-cost areas.

Slide 10 outlines Flowserve's recent global expansion of low-cost manufacturing sites, quick response centers, and research and development centers over the past 18 months. In the Middle East, we established a new training and service joint venture with Al Rashad in Saudi Arabia. In Eastern Europe we launched a low-cost steel manufacturing and quick response center in the Czech Republic to serve that region. And last month in Asia, we opened up a major, new pump, valve, and seal manufacturing site in Suzhou, China, to provide significant capacity to support the growth we're seeing in that region. We also established a new pump joint venture in Changsha, China to support additional capacity and capability in providing large water and pump solutions worldwide.

And in Coimbatore, India, we dedicated a fourth valve joint venture manufacturing plant and a wholly owned pump manufacturing plant. In Bangalore, India, we are expanding our valve manufacturing facility and we've established a new valve research and development center and expanded our pump development center. And in Chennai, India we expanded our seal engineering center where a significant amount of our seal designs are developed. In Mexico, we expanded our Taxcala seal facility due to increased demand and recently opened five quick respond centers throughout South America. All of these additions support our strategic plan of developing high quality, low-cost manufacturing and engineering facilities close to our customers to support their requirements worldwide.

In addition to building out our global manufacturing, quick respond center, and learning center capability, we also continue to increase our internal R&D as well as our customer-funded R&D in leading edge research and development to maintain what we consider to be a competitive technology advantage in the marketplace. We're employing high technology manufacturing capabilities such as laser machinery, which improves quality and durability, electron beam welding, which reduces scrap and improves through-put, and using computer-aided manufacturing, which is helping to reduce cycle time for new product development for our customers.

Chart 9 covers just a few example of the many new products we have recently released. The pump division announced our new IPS template products that has built in electronics and variable speed drives that enable computer-based systems to monitor and control a pumping system to reduce the total cost of ownership for our customers. Our largeX solution and our valve division provides a digital, electronic capability with intelligent self-diagnostics to monitor a complete flow system to maximize asset utilization and minimize unscheduled downtime, and in our seal support systems, reduces flew emissions below critical environmental tolerances through a proprietary, integrated, system design concept. We are also partnering with global standards organizations and universities to leverage public funding, internal funding, as well as customer funding to accelerate the adoption of these new technologies.

Before I hand things over to Mark to handle the financial and segment performance in more detail, I want to summarize with one last slide that speak to our core strategies, our near-term focus and our scorecard on how we did in the first quarter. As we've discussed on prior calls, the near-term focus of our six core strategies comes down to a few things. Emerging market expansion, operational excellence, superior products, and solutions, and driving our integrated platform to reduce costs and complexity in our operations. The financial results for the first quarter of 2007 show that we've been executing well against these objectives. Bookings were up 24%, sales were up 23%, operating income was up 64%, net income was up 81%, and earnings per share was up 84%. You can see why I'm truly proud of our global team for their exceptional results. I would now like to turn the presentation over to Mark for a more detailed look at the financial results, our segment performance, and our outlook for the remainder of 2007. Mark?

Thank you, Lew, and good morning, everyone. I'm going to starts on page 13 of the presentation that's on the website. What I'm going to do today as Lew mentioned is review division performance, also talk about progress on SG&A leverage that we talked about on the last call. We'll review working capital and cash flow, and then we'll update you on our progress on our targets and initiatives. Before I get into the specific presentation, let me outline some specific themes.

First of all, we saw very good operating income leverage to sales during the quarter. This resulted from our focus on SG&A leverage as we start to get traction on our initiatives during the first quarter. Also, we were able to offset a majority of the impact of the shift to more original equipment, particularly in the pump division, as a percentage of sales through continued operational excellence, increased absorption, and improved pricing.

I also want to comment briefly on corporate expense. A lot of that is reflected in the "all other" segment in our presentation. Corporate expense for the quarter was slightly higher than we anticipated, but what I do want to point out is the first quarter does have a high burden of global financial costs, particularly we have a lot of audit activity with our '06 audit. We spent $5 million in audit fees in the first quarter, and we also spent approximately $3 million in connection with FIN 48, a majority of which was in the first quarter. As you look over the subsequent quarters, we'll see audit activity increase in the fourth quarter, as we go into our '07 audit. And our expense on the tax side will be oriented more towards tax planning strategies, which will drive -- continue to drive our rate down. Also we'll talk briefly about the demand for working capital as we've seen order growth and we remain focused on on-time delivery. I will call out we've been able to offset a great deal of this with advanced payments from customers. Finally, I'll wrap up with where we are in terms of driving towards our targets.

Turning to the consolidated financial results, as Lew mentioned. We had very strong booking growth. Bookings increased $210 million year over year to $1.89 billion, representing a 24% increase year over year. It's important to point out that growth was strong in all divisions. Sales increased $149.5 million to $803.4 million, representing a 23% increase as we started to see an acceleration of sales on the heels of the strong order growth over the last six quarters. Gross profit increased $47.5 million to $265.5 million, an increase of 22% year over year. This was driven by strong performance, continued strong performance in our valve and seal industry, and again in the pump division. We saw the impact of mix shift, but that was largely offset by pricing operational excellence and the other concepts we talked about before.

SG&A increased $22.9 million to $203.6 million, representing a 12.7% increase. It's important to point out that the dollar amount of the increase includes approximately half of an increase in selling expense. We added about 7% in headcount in the selling organization from the end of the first quarter of last year. Also with respect to the dollar impact year over year, there was about a $6 million currency impact. More importantly, if you look at SG&A as a percent of sales, we saw efficiency of 230 basis points as we start to get traction on our SG&A leverage. Some initiatives we put in place during the first quarter, we saw some traction, and we expect more during the course of the year.

Operating income increased $26.3 million to $67.4 million, representing a 64% increase. If you look at that compared to sales, you can see that we got operating income leverage of 3 times sales. Earnings per share increased $0.27 to $0.59, representing an 84.4% increase. I want to comment briefly on our tax rate. We've talked about this before.

The tax rate for this quarter was 36.6% compared 32.7% last year. Last year, there were a number of discreet items, so I will focus on this year. During the last call, we talked about the annual 2006 rate of 39.1% and I said we expect the rate this year to be less than that. I want to update that. As we look at our rate going forward, we expect that our rate will be 38% or below. Now we will have volatility during the quarter as a result of FIN 48 and the requirements around that. It can create tax volatility. And the other thing the rate will depend on is the time and expense we put into tax planning this year. But we do intend to invest.

Turning to our pump division, they had terrific performance during the quarter. Good operating income leverage. Booking increased $162.6 million to $658.2 million, representing a 33% increase. But what I want to point out here, and it will become more evident on the next slide, is that we saw strong after-market growth during the quarter in bookings. Sales increased $90.6 million to $418.7 million, representing a 28% increase as we are starting to see the acceleration of the prior period order growth. Gross profit grew $22.7 million to $117 million, or a 24% growth. Margin did go down by 80 basis points as we talked about earlier. We saw a 700 -- over 700 basis point shift to more original equipment. I'll talk a little more about that at the end of the presentation, what impact that has. But we were able to offset that by pricing, operational excellence, and absorption to a large degree.

SG&A in the pump division increased $9 million to $76.8 million, or 13.3%. And SG&A as a percent of sales was down 240 basis points. Operating income increased 14.7% -- excuse me, $14.7 million to $41.7 million, representing a 54% increase. Two times sales growths in terms of leverage. And operating margin improved 180 basis points as we are getting traction on our operating margin improvement.

The next slide which is slide 15 highlights what I talked about earlier. You can see in the bookings mix that we saw a $48 million increase in the after-market bookings, a 27% increase year over year. Now the significance of this is this is bookings that will tend to convert quicker than original equipment. Now this does not just reflect that we're capturing some of the project orders that you've seen because a lot of those are just being put in service. The driver of this growth is really around our end user strategy. This is the same strategy that we started employing three or four years ago in our seal division and have led to its success.

Turning to the flow control division or valve division. They had excellent performance during the quarter. Again, good operating income leverage, this resulted from continued manufacturing excellence, and SG&A leverage. Bookings increased $41.4 million to $309 million, representing a 15.5% increase. Sales increased $50.8 million year over year to $268.6 million, representing a 23.3% increase. As they are, too, getting traction on the order growth they saw last year. Gross profit increased $17.7 million to $93 million or 23.5%. They were able to sustain very robust gross margins year over year. SG&A increased $6.8 million to $58.6 million, representing a 13.1% increase year over year. They remain very focused on cost control. Operating income increased $11.2 million to $36.4 million, representing a 44% increase. Again, this is two times sales in formal leverage, and operating margin increased 190 basis points. An excellent quarter for the valve division.

The seal division or flow solutions had continued strong performance. They had gross margin improvement, SG&A did increase, this primarily resulted from our investment in our QRCs as we put personnel on location. They had selling resource increases, they added approximately 50 selling heads since the end of the first quarter last year, and they also had been adding engineering resources, which are in their SG&A number. Going through, you can see that bookings increased $12.7 million to $140.6 million representing a 10% increase. Sales increased $11 million to $129.2 million, representing a 9.3% increase year over year. Gross profit improved $5.4 million to $57.2 million, and gross margin increased by 50 basis points. As I mentioned earlier, SG&A went up by $4.1 million to $34 million, and this does include that investment in the QRC resources, selling resources, and engineering resources. Operating income improved $1.5 million to $25.1 million, and operating margin remained strong at 19.5%.

Now what I'll do is review our traction on SG&A leverage. You can see that in selling and marketing expenses, we did get some leverage year over year. As I pointed out earlier, since the end of the first quarter last year, our headcount in the selling organization has increased by 7%. We added those selling resources during the course of last year, but we did get leverage year over year. Global financial professional expenses, this does include corporate and what is embedded in the division. You can see that we got leverage of 1.1% as a percent of sales year over year. I do want to point out that the first quarter is our heaviest quarter for audit related fees and tax assist fees.

IT expenses representing a lot of our investment in our ERP systems. We did get some leverage year over year. We will continue to invest in our systems. Salaries and fringe excluding selling did -- we did get leverage year over year. Again, we added a lot of resources during the course of last year. Engineering and other resources to support our growth. We should start to see scale on those resources during the course of this year. We did see improvement in travel. We still have some more work to do. But we did see an improvement year over year. So in all we saw a 230 basis point improvement as a percent of sales year over year, and we are getting traction on our initiatives. Some we did put in place in the first quarter. And we expect to see the benefit during the course of the year.

Turning to primary working capital, we did see that we used working capital to support order growth. I'll call your attention in the first quarter to inventory, 19.5% as a percent of sales or $627 million. This was driven by increases in work in process, finished goods, and raw materials. And I can tell you from some of my site visits I can see that a lot of these sites or many of them are carrying safety stock, and that can include sometimes motors to attach to a project that's going out because the important thing is that we want on-time delivery. And in the supplied market that we're in right now, we want to make sure those supplies are available. You can see that we were able to offset a lot of that impact with advanced cash from our customers. $157 million. So we were able to get these to in a sense prefund our inventory to supply to the customer.

Looking briefly at a summary of our cash flow statement, and we talked about earlier you can see the impact of the increase on working capital. Capital expenditures were $22 million for the quarter. This includes our investment in India and China, expansion of our test loop capabilities in manufacturing, and also our investment in our ERP and IT systems. Also I'll point out you can see the impact of our share repurchase. There were 500,000 shares that were purchased during the quarter, and also at the beginning of the year, we settled some shares that were purchased at the end of the year. It was about 100,000 shares.

Turning to our outlook, let me give you an update or report card of where we are in our two initiatives. In gross margin, we have seen some material increases in nickel and titanium, and accordingly stainless steel components. Carbon steel year over year has stayed flat or come down. We have been able to offset a lot of this in pricing. Also the impact of OE after market mix. A good rule of thumb for the pump division is approximately 100 basis point shift will impact margins approximately 30 basis points. And as you can see if you do the math for the first quarter, we were able to offset a lot of that. Also business segment mix. As pump becomes a bigger proportion of our overall sales, it has an impact on our gross margins. We've been able to offset that with volume leverage or absorption, low-cost sourcing, operational excellence, and pricing. The point I want to make here is that the items in red, while they may represent a headwind to gross margin improvement, they are not a headwind to operating margin improvement as you can see by our performance in the first quarter.

With respect to SG&A, we have seen benefit of driving down professional -- financial professional fees, and as I talked about our first quarter is our heaviest quarter for the year. We've seen progress on headcount management. In the division SG&A and scaling corporate overhead, we've put a lot of those initiatives in place during the first quarter, and we started to see some traction, and we expect to see better traction during the year. We have seen the benefit of reduced travel. Also, we've seen an increased expense in connection with our ERP implementation, and our -- our selling expense as we start to realize the full-year benefit of the selling resources we put in place in last year, our strong order growth, and our strong sales growth.

Turning to the final slide, slide 24, I'll just summarize it, as Lew mentioned. We see sales in the rank of 3.4 to 3.6. We also see an operating margin improvement of 200 to 300 basis points. Bottom line, we've made good progress. We have work to do, but we're very positive on this year and going forward. With that I'll turn it over to questions and answers.

(OPERATOR INSTRUCTIONS) Your first question comes from Mike Schneider are Robert Baird.

Good morning, guys.

Good morning.

Congratulations on a great start to the year. Start on gross margins. You're expecting them to increase 230 basis points this year. I'm just curious, though, you started the year down 30 basis points. What are the principal swing factors as the year progresses to kind of take you on that acceleration, especially knowing that project mix probably likely will stay at the type of heavy waiting in the mix that it is today?

Yes, Mike, a couple of things. One, if you look at the performance of our seal performance and valve division, they've had strong top line performance, strong margin performance. We believe that will be accretive to our margins this year. Also if you look at the pump division we were this year able to offset a lot of the shift mix with absorption, pricing, and operational excellence. And if you look at the sequential quarters, you can see that absorption really does play a factor in our ability to achieve gross margins. So depending on how sales go through the year, we see the opportunity for additional absorption. And also just the opportunities we've had around pricing. As mentioned in the 10-Q, we did have a price increase in our valve division during the first quarter. And we also see opportunities in that continued in our other divisions, as well. And also keep in mind with some of these projects, we had price increases during the course of last year. So we'll start to realize those as those convert to sales. As I mentioned, there is, there's headwind as the items that I talked about. But at this point we still see the opportunity that we can drive through that. And to add to that, as you know, we have a good deal of capacity in China, in India, also we added capacity in Mexico. And we think that as a component of operational excellence will continue to help us drive margins.

Great. Thank you for that. And just as a follow-up. Now that you had 2006 behind you and you have had this burst of project shipments that have gone out the door, I wonder if you could do a little review for us. Because historically closer have had problems basically capitalizing on the gross margins they thought they had in the backlog on some of these largest projects. Wonder if you could just review for us what your hopes were for gross margin on some of these largest projects in '06 and early '07 and what's actually coming through. And are you confident that the balance of '07 will turn out as you hope to have priced these projects?

Yes, Mike. I mean, we -- we do monitor what we call our in and out multiplier for these projects. And that's why we remain very focused on on-time delivery. Because one of the things that can impact your in and out is going o be any lost damages that you have to pay. Liquidated damages, which we by term stay very focused on. But as we look at it going forward, we feel comfortable relative to our margins because of the discipline around pricing. The effort we go through in terms of reviewing regularly execution and execution around operational excellence. We also do review as I mentioned earlier the in and out multipliers. So if we see something that is impacting it, we diagnose it and work to it very quickly. I think we talked about some of that on the third quarter of last year.

And also the other thing that gives me some comfort on the gross margins as we talked about earlier, you saw an increase in the after-market bookings. That is not only around some of the project increase because keep in mind these projects came around around six or seven quarters ago. A lot of them are just getting installed and still may be in their warranty period. A lot of this after-market growth is around the end user strategy, which is what you saw in the seal division three or four years ago. I think a lot of those things are what at this point give us comfort that we can still target within that range. We know we've got headwinds of mixed shift and segment shift and everything. The thing I want to point out is that doesn't necessarily mean we're going to be sacrificing operating margins. At the end of the day that is our primary focus. So, the other things that we talked about, Mike, before is continued program management around warranty expense. Focus on term and conditions and contracts, elements around risk mitigation, and that's what gives us the comfort.

And if I may, the warranty expense number for the quarter, what was it and how does it compare to a year ago? That's probably the best metric to track on this in and out version. Is that--?

Mike, you're kind of knocking in and out on us. You might be on your cell phone. Let me answer the question I think you asked. On warranty expense, our warranty expense was down. And a lot of that is through the program management. And just the focus and effort around that. That's obviously one of the critical indicators for us in terms of how we're executing on our contracts. And so that's probably, an indicator except for items that may come up, an indicator of how we're executing. And so I think that dovetails right into our ability to believe that we can continue to drive gross margins.

Thank you.

You're welcome.

You're next question comes from Charlie Brady with BMO Capital Markets.

Hi, thanks. Good morning, guys.

Good morning, Charlie.

Can you -- on the service centers and specifically within flow solutions, the QRC network expansion, sort of where are you in a timeline of being in a level where you want to be on expansion of those type of facilities?

Yes, Charlie. Good question. We've added QRC strategically over a period of time. In terms of where we are in the timeline, it's not like we're a retail shop where we have a goal to put 1,000 stores in over the next 10 years. Really the way we set these QRCs are very customer driven and opportunity driven. And so what I would say about that is -- you saw as Lew mentioned our acquisition in the Czech Republic, that really serves in a sense as a QRC. We can leverage some existing facilities or strategically we put one in China. So I would say there's not necessarily a timeline because the objective is not to have X-penetration because we'll let the -- we'll let the market drive us, and we'll drive the market both. So I think we made good progress in our QRC expansion. We're also seeing the benefits of that as well. Keep in mind it's not just in the seal division. We have what are called service centers in our pump division. They're in effect QRCs. We have a number of those, as well, and we'll continue to either co-locate those in large plants or put them in very large points of aggregation where we have customers needing our service and maintenance capabilities.

As a follow-up to that, -- as far as adding headcount or resources into those service centers, you had a little bit of ramp-up this quarter, we expect to see that kind of going forward on sort of a steady, continuous ramp-up, or you kind of at the level where you want to be?

Well,--.

Personnel-wise?

Yes, sure. I think what you do is you ramp up and then you see the benefits of them. When I step look and look at our seal division, the P&L is really a good indicator of what a service organization is like. It does -- it does tend to have higher SG&A as a percent of sales. And a small change there can have an impact on the percentages. The fact is is that as we allocate those resources, as we put them on the ground, we will get -- they will ramp up, and we'll get service benefit. So I think you'll continue to see this. We'll put them into the ground and we get a fairly long-term benefit from them.

Thanks.

You're welcome.

Your next question comes from Ned Armstrong with FBR and Company.

Yes, thank you, good morning.

Good morning.

First question regarded your bookings by market. You showed some pretty good strength across the board there. What stood out to me I think was chemical being very strong. And we're hearing that from a lot of people. That said, chemical is notoriously cyclical. I'm just wondering how you're seeing that market with -- looking out a little bit further as to whether the strength will be sustained for quite a while or whether you're starting to see signs that the growth patterns may be abating some.

Yes, Ned. A couple things in response to that. We did see good growth during the quarter. It is a cyclical business. There's many views as to where that business is going or where the output is going. One of the things that I want to comment on is there's multiple aspects really of what drive our business. If you look going forward, I said there's different views on outputs. But if outputs stabilize or decline that can impact the market.

But there's another driving factor that impacts us, and that is if you look at what's happening with chemical capacity. Chemical capacity is shifting. It's shifting to low-cost areas of the world. So while output may remain stable or may decline, there will continue to be a capacity shift to China, for example. You're seeing them come up in China or perhaps Latin America, or in the Middle East for that matter because they have the feedstocks at a lower cost right there nearby. So you got to look at the dynamics. We're not really going to call the chemical market out there. But what we do see is an opportunity around infrastructure. And as they move these plants, they don't shut down one and then wait and build another one. There's in a sense dual plants running for a period of time. So we certainly see the opportunity in the chemical industry as this infrastructure shifts to low-cost areas.

Okay, good. And then with regard to capital spending, your capital spending this quarter was about 2.7% of sales. Is that a level that you believe will be the rough amount of expenditures going forward, or was this quarter particularly heavy because of ERP expenditures, or even maybe a little bit light for other reasons?

Yes. Ned, we -- what we did is we -- we've indicated the end of the year that we expect to spend 85 to $90 million of capital this year. Keep in mind a lot of what you see in the first quarter is we did open our plants in India and China. That did have an impact. But also we are -- we're spending on ERP. And as I've mentioned before, we do expect that we'll have capital expenditures for ERP during the course this year, and some into next year. This is a multi-year plan that we're going through. But you did see the impact of the India and China plant also.

Right.

Also we -- we made some investments in some test look capabilities, and we're looking across our footprint to make sure we have up to date machinery for productivity, the expansion in Taxcala which occurred last year. So the answer to your question is 85 to 90 for this year is what we're seeing. And if we change that we'll let you know. And we'll look at our capital plan at the end of the new year for next year. Really dependent upon the type of returns we've gotten from where we've invested our capital. But more importantly, we'll see where the markets are at that point in time.

So for future years, that 2.7% maybe, maybe not, it's hard to tell until you reach closer to those years?

That's right. My spend snow strategic. It's not catchup capital. So if it was catchup capital and I was way behind the curve, I could probably call that we'd have some spend going out into years. This is truly strategic capital spend that we will augment, adjust, increase, decrease strategically as the market demands it as our needs demand.

Got it. Thank you.

Your next question comes from Scott Graham with Bear Stearns.

Good morning.

Good morning, Scott.

Several questions for you. What was pricing in the quarter, and did that offset raw materials?

Our three divisions all raised prices in the quarter somewhere between 2, 4, some even 5% across the board. That covered in most cases raw materials, in some cases actually more than raw materials, some of our engineering plants may not have covered all the raw material increase. But the industrial plants did. So overall, our pricing increases did a good job of covering any raw material fluctuation.

Okay, thank you. The investors that you were making around the world, this is all good stuff. I'm just wondering if you were to sort of fully load SG&A or the incremental costs from these -- from those investments, what would the SG&A number look like in the -- in the first quarter on a percent of sales basis?

Help me understand what you mean by fully load our investments worldwide.

Well, a number of these investments that have been made were actually made over the last, quarter, couple of quarters, even three quarters. Obviously not the ones that are four and five quarters because that would have been anniversaried. But if you look at the map of recent global expansion that you're talking about, obviously there have been a lot of investments made, and only -- not all of that has fully hit the SG&A. Particularly the first-quarter stuff, I guess I would maybe isolate that. So if you were to say what the SG&A number on a run rate basis looks like right now fully loaded for I guess particularly these first-quarter investments, what would that number be, 20, 30 basis points higher or something like that?

No. I mean, I -- a couple of things, Scott. If you're looking at 20, 30 basis points higher as a comparative year over year. One thing to keep in mind and I called out, is in selling, really in all of our headcount, we added headcount during the year. While we'll have the full effect of it this year, we'll also start to see the leverage from that. I think we have legion opportunity in terms of the investments in headcounts that we had last year. The flip side is, the capital spend, if you're talking about what we had in India and China, it's -- it's tough to say as I sit right now, what the SG&A impact will be of that, but if it is in terms of there's a burden, it will be how quickly we get those plants up to speed. And fully leveraged. I can tell you from having seen them that there's a lot of opportunity in that local market, and we have a lot of opportunity to ship internally, low-cost components. So I don't -- I don't expect that to be a big drag. And I guess I'll go back to we still see the opportunity around SG&A leverage that we talked about on the last call year over year.

Okay. Let me ask this question maybe in a different way. These investments on this page, on page 9, this was all first-quarter stuff?

Let me -- let me look at page 9.

No. No, the Czech Republic was an acquisition we made last year. Saudi Arabia, we expect to actually open that facility towards the end of this year. Changsha was a joint venture. Suzhou, China, we did inaugurate the facility last month. Some of these are in our joint ventures, as well.

The stuff that Lew was talking about, that we expanded here, we expanded there, that fortunately I taped the conference call. Those expansions that Lew was referring to, that was all first-quarter stuff?

No. No.

The ones he was talking to, a lot of those occurred last year. We're just highlighting things that we've done really over the course of the last year. And the way I would look at it, I'll just kind of step back -- I don't know that as a -- SG&A as a percent of sales, that these are really going to have any upward burden at all. If anything because they're in low-cost regions, they could have a downward burden. I have not done the specific math on that.

All right. That's fine. Where do you put your advanced payments on the balance sheet?

Accrued liabilities, deferred revenue.

I see. Okay. Thanks very much.

You're welcome.

Your next question comes from Mark Grzymski with RBC Capital Markets.

Good morning. And thank you.

Hi, Mark.

Just curious, with the strength of the oil and gas market, it's been really hard to size things up from a competitive landscape, from a competitive perspective. I'm curious your takes on the competitive environment in the pump area, especially with your growth into new markets in Asia, et cetera?

Well, we are constantly looking at all our numbers. Obviously in the pump side our major competitor is [Sazha], [Ebar], there's a few others out there. We don't really discuss our competitors. We have very good competitors. We feel we are gaining market share and doing very well against all our competitors.

Is there any way to then kind of relate that to the pricing environment from a -- is there pressure from -- on pricing from a competitive standpoint?

Well, in the marketplace there's always pricing pressures that you have. But the fact is we don't normally sell as being the low-cost personnel in the industry. We sell being the supplier that supplies on time, with a product that works the first time. Therefore we win a lot of jobs not being the low-cost person.

Mark, it's fair to say, and we talked about this before. I think the biggest driver of our pricing is going to be the strategic opportunity of that location or the after market. And overlaid with the discipline we put around our pricing system and pricing process. There is -- there's a lot of business out there, as Lew mentioned. We have good competitors. You can see the order growth year over year and see that we have results that are comparably higher than theirs are. But it's good -- good, strong markets. The pricing is primarily determined by our own internal discipline.

Okay. Okay. And then just last question, looking over the 10-K, the UN oil for food investigation, I think it says that, it should come to a head here in Q2. Is there any way to quantify that impact, as an investor or, just as -- you guys kind of looking at it?

Well, as previously disclosed in our filings, that you've read, we're cooperating with the SEC investigations. This is an old oil for food program. And of course a lot of other companies are also making similar investigations. And ours is directed by our outside Security Counsel. What we really discovered was some non-U.S. personnel authorized some -- about 600,000 euros payments to Iraq-controlled bank accounts. These payments weren't properly recorded in subsidiaries' accounting records, but were expensed. They were expensed on their books. So we've taken the action, we've terminated those non-U.S. employees, and we'll continue to disclose to everybody with the ongoing investigation with full compliance of the SEC requirements. It was not that big, in other words.

Right. You don't expect to there to be some penalty that -- larger than we could fathom at this point?

No. There may be a penalty, but we don't expect it to be very large. It will be a fair penalty for what we've done.

Mark, if we -- if we expected something that was material we'd have an obligation to disclose it.

No, yes -- of course. Thanks for taking my questions, guys.

(OPERATOR INSTRUCTIONS) The next question comes from Wendy Caplan with Wachovia.

Good morning. The capacity additions that you referred to in Mexico, and China, and India, if we assume that our current capacity or before these additions was X, could you speak to the net capacity levels? In other words, are you on a net basis increasing capacity, keeping it slack, substituting capacity from higher cost to lower cost regions. How should we be thinking about that, please?

Wendy, we're not really substituting capacity. With the orders growths that you've seen, especially, this last quarter and obviously the last seven quarters, we are adding capacity to the system. And we're adding low-cost capacity around the world, and adding it where we need it. The Indian capacity is really mostly for the Indian market, but we will do some export. The China capacity is for the China market, and we will do some export. And of course our joint venture with Changsha is adding capacity in the water and power side, mostly for the China market. So it's not a substitution. It's actually adding new, low-cost capacity.

And just, when we talked a little bit about the test loads, and as you know in the engineered, those can become the bottlenecks to getting a project order out. That's why we've been investing in that in existing facilities, is to to make sure we have that appropriate test loop capability which is not only important for getting the order out originally, but also when you take it in to service the pump going forward, you'll need to test it before you send it back out to the customer.

And in Mexico we mentioned, we -- we added a significant amount of machining centers, not justice machining capability, to do automated machinery. And that's because of the demand around the world for seals.

Okay. So is there a way to quantify in terms of how much capacity we're adding?

We really wouldn't be giving out information like that. I can just tell you that we are adding significant capacity because our orders growth has been significant.

Okay. And you've talked a lot about margin and SG&A, but, if you calculate the flow-through, the incremental margin by segment, it's -- or consolidated, it's a pretty low number. And I understand there's some issues in the quarter specifically. But how do you strategically think about this flow-through? Most companies in the -- kind of in your space, in the industrial space tend to think about it in terms of kind of 30 to 35% flowthrough? Yours was about half that this quarter. How do you think about that? How should we think about that strategically? Is that a stated goal? Or -- if you could comment on that, that would be helpful. Thanks.

Sure. I mean, I -- I may not be picking up the right number, but from an operating margin flow-through, an operating flow-through, we saw three times that of sales. And we were very pleased with that. And strategically the way we think about this and I think we have talked about this before, I mean, we want to drive to our objectives over a long period. So we will make investments where appropriate. We'll add headcount and engineering talent to get this thing, we're positioning this company for not only next year but years out. If you're referring to the gross margin flow-through, that we've talked about before, we have seen improvement certainly in the valves and seals division and strong margins there, but there is an impact from, as we've talked about before, the shift mix in the pump business.

The way we look at that is we take a step back. It does tend to impact gross margins. But if you look at project work versus after-market work, project work will tend to carry lower SG&A burden. So even though it may have gross margins doesn't mean that it can help us accrete to our operating margins. So that's the way we look at the margins. We see the impact on the gross margins that mix shift can have. We continue to work to offset that with pricing operational excellence. And other initiatives that we have.

Also on the operating margin line, we want to see continued leverage there. One of the things we're focused on this year is SG&A leverage, so not only just letting sales drive SG&A efficiency but more importantly go specifically after certain line items to drive SG&A reduction. And then one final area is around the corporate side. As I mentioned we did see the corporate expense in that segment was $35 million. Keep in mind that has inner company profit elimination and our foundry expense in there, but a bulk of it is corporate. We will continue to focus on driving that down. A big portion of that in the first quarter was our financed professional fees globally which we expected to be high.

Okay. And I have one last question if I could. The pump order book for Q1, were there any unusual projects in that order book in terms of particularly large orders, or would you consider them typical?

Well, we've seen our -- the size of the projects get bigger consistently over the last -- last year. And we have seen more complex projects come through. But, Wendy, this is an overall trend that we've seen in the project work. But what we were very happy to see was the growth in the order book and our after-market business. And as I said, this is being driven by a real focus on our end-user strategy around driving the after market, not necessarily for projects that we're installing at that point in time, but going out to other existing projects and obtaining after-market work.

Thanks very much.

You're welcome.

You're welcome.

Your next question comes from James Foung with Gabelli and Company.

Hi, guys. Good quarter.

Hi, Jim.

Thank you.

Thanks.

Just have one question here. Could you just talk about your use of cash. Seems like your stock buy-back prosecution as you indicated, would be completed in the second quarter. But your dividend's been reinstated. Just talk a little bit more strategically how you plan to use your cash.

Well, yes. We've talked about a couple of things, and we've indicated what we expect to spend in capital this year. And as I talked about -- on the last call, we tend to generate a lot of our cash flow on the third and fourth quarter of the year. So it's fair to say at least over the short term we think, we'll be able to use our cash for continued strategic capital investment. To support working capital needs as required. Going forward we'll look at all the alternatives. You've seen the activity last year. We did declare a dividend. We'll review that on a periodic basis. We have -- we are in the process of wrapping up our share repurchase program. We'll look at capital spend and perhaps some other strategic alternatives. We haven't made a call yet at this point. When we do we'll let you know. I do anticipate that it will just continue with the straightforward blocking and tackling over the next quarter or two, and we'll evaluate that probably towards the end of the year.

Maybe you can talk specifically about acquisitions. Could you talk a little bit about your appetite for acquisitions, what the pipeline looks like for you, and what you're seeing out there?

Right now, Jim, there's a lot of things out there to look at. Valuations are very high. We're constantly looking at what's available. We have not made any large acquisitions in the last couple of years. We've made some small, very strategic acquisitions, in the low millions of dollars. Going forward in the very near future, we'll just continue to look. And if something comes up that we think is the right thing for our shareholders, we'll look for seriously at it.

You think you'll be ready for a large acquisition in the next 12 to 18 months?

I don't know if we really want to comment on that. In the next 18 months, the Company will be generating an awful lot of cash. It's getting a long stronger. Our ERP systems will be a lot better. We'll make those decisions when the time comes.

Jim, it's safe to say as you look out, as I mentioned we made good progress and we still have work to do. So I think more importantly is how we will think about an acquisition. We will consider its relative strategic opportunity to the Company. But we will also consider the burden it could or could not put on this company, its complexity. We do keep in mind the ERP systems that we have in place in our platform. So we'll be mindful of all that as we look at opportunities out there. Having said that, if you look at our organic growth over the last year and a half, as Lew has said before, that's almost like an acquisition in and of itself. And it has a lot of attributes to it. So we'll continue to keep an open mind and be strategic. We certainly don't feel the need to do anything.

Okay. Thanks, guys.

Your next question comes from Adam Comora with EnTrust Capital.

Yes. I just wanted to, Lew, just get your thoughts on the marketplace that you guys are currently in. We're starting to lap some pretty big numbers with some more pretty big numbers. How -- can you just give us your quick thoughts on - how you might see the rest of the year playing out in terms of bookings and the overall market.

We really don't go forward on things like that. Obviously, we'll talk about what we just saw in this quarter, which is obviously a very strong market. Going forward, what we see out there is still a good market. The -- but we don't know how it's going to change over the next year or so. So far, it's been very good.

I mean, one message with that -- and we commented a little bit, is we have and continue to remain selective. So I think our criteria and our selectivity focused across our strategic capacity is going to be one of the drivers in terms of how we take project orders going forward. And other thing is we will continue to focus on growing our after-market order book. We saw good progress. We were pleased to see that. It can fluctuate certainly from quarter to quarter, but underpinning that is a strategy to go and pursue additional -- end user strategy additional after market business.

Okay. Thanks.

Your next question is a follow-up from Charlie Brady with BMO Capital Markets.

Thanks. Just looking at the after-market growth in pump, which was -- obviously very healthy. Good to see that. Can you give us what it looked like sequentially from the fourth quarter, what the after-market revenues grew.

Well, revenues -- revenues, the growth for revenues during the first quarter were 10%. It was $15 million increase. I was referring to our bookings growth. And if you remember last year, I believe the number for the full year on after-market growth was 8%. So we did see some sequential growth versus all of last year. I don't have the specific number quarter by quarter. I think more importantly was what we were talking about was the order growth. We did start seeing in the middle part of last year the after-market bookings growth to start to trend up. I think this is the -- you can see in the relative disclosures, but I think this was the highest quarter over the last three or four quarters.

Thanks.

Yes. As a percent of bookings growths, right.

(OPERATOR INSTRUCTIONS) Your next question is a follow-up question from Mike Schneider with Robert Baird.

Guys, a couple follow-ups. First, just on this idea of flow-through margins. Dovetailing on the previous question of after-market mix. It's reasonable to suspect as the mix begins to shift back towards after-market pump sales, based on the order trends you saw this quarter, the flow-through should actually rise with time, is that correct?

Yes. If we go to -- if we go to the example that I talked about on the last call. As you see shift, all other things being equal, the more original equipment, it will tend to suppress your margins. And I gave you a rule of thumb for the pump business. As it starts to shift the other way as a percent of mix, we should see lift in our gross margins.

The discrepancy between the peer group I guess and your mix outside versus--?

Mike, you're breaking up.

I was saying that the mix shift right now that has occurred in your business is really what explains a discrepancy to the peer group. Is that fair, just because of the significant portion of projects you're doing?

Yes, I mean, not having my peer group data, that may be on the gross margin side. You got to keep in mind, I don't know that we really necessarily have a peer group as a consolidated company because we have a valve in the seal division which have very strong margins.

Right. Right. And then as far as bolstering the selling portion of the enterprise, you mentioned you added 7% to the headcount last year. Can you give us a, kind of a trend line, are you investing as aggressively in 2007, or is it a case now where the incremental hit to the P&L has already been felt and we should begin to leverage those investments in 2007 and '08?

Yes. I think we're going to leverage those investments in 2007 and 2008. If you look at our orders for the first quarter, you can see how the 7% adds helped.

Right. Right. Okay. And next topic on the severance agreement, the Q had a renewed severance agreement that presumably has been signed by a number of officers. What is that intended to accomplish, and what should we read about that going back to this capacity discussion as well? Because it seems to intimate that the--.

Nothing. There's nothing to read into that. Many companies have standard severance agreements. We -- our HR organization and everything went through just to make sure that they formalized it. And in connection with current disclosure requirements put it out there for the public to see. So there's nothing else to read into that.

Okay. And final question. On the ERP rollouts, can you give us a sense of how many plants have gone live now, either year to date or in the last two quarters. And how many are scheduled for the balance of 2007 and basically what your experience has been.

Yes, let me start the math the other way. I think a couple of years ago we were at 60 ERPs, we're sitting at around 48 right now. I think the implementation includes 4 or 5 since the middle part of last year. And we're constantly looking at additional implementations. What we do, Mike, and we talked about this, is we make sure as we go through each implementation that we do a deep dive and learn whatever we can. And that, I think is the important message on the methodology that we're using. Is we make sure we learn from everyone so that we can drive increased efficiency. I don't know -- we've got a couple more slated for the rest of this year. And the thing I am going to point out is our goal is not to go down to 1. And in some instances, if we -- when we sell a company or when we consolidate it, we may take more than one ERP system out. So it's -- I think the message is, back to kind of my retail discussion. We do have a plan but we modify it every day based on risks and opportunities that we see in the implementation.

Okay. Thank you again.

Yes.

Our final question is a follow-up question from Scott Graham with Bear Stearns.

One question on tax, one question on productivity. The cash flow item, Mark, that excess stock compensation is a tax-related item, was that -- that run through the P&L in any way?

No. No.

And secondly, when you say your tax rate's going to be below 38 and perhaps that's just where you're comfortable in telling us, but obviously this quarter it was nicely below 38. Is this quarter's rate sustainable?

Well, I mean, we've talked long term. I haven't been bashful to mention that I think we can get our rate certainly lower between, 30 and 35% is what I've talked about. I think the words of caution I had was if you look at the requirements around FIN 48, and we spent a lot of time and money looking at that. It can create volatility in all companies' tax rates because of the way you have to accrue. You've moved away from what was FAS 5. And now move to the requirements of FIN 48. So there will be volatility. But as I look long term at kind of our recurring rate, at this point I'll just say, we see at or below 38%. Some of that is going to -- is going to depend on the impact, either way on FIN 48. But also I think a big portion of that in -- and what we'll be seeing is our investment in tax planning strategies. And that's where we may choose to -- some of our global financial professional fees during the later part this year will be put more money into that because we'll get a return on it. So I do think there's continued opportunity. We're very pleased with our rate for the quarter. It really represented the marginal corporate rate of 38%, and we had some benefit from foreign operations.

Okay. On the productivity, you disgrace been working hard on improving your supply chain, taking costs out. I think the number last year was something like $40 million all told, when I added everything up. I guess I'm most interested in what you're doing in lean and what you're doing on the purchasing side. For example, are you still getting, let's say, 10, 20%, and more percent savings on consolidating purchasing, and how are the lean initiatives going?

Well, first of all, we'll start off with lean. We are instituting lean in a lot of the factories across the world. In fact all the new ones have lean in it. And we have a group in our strategic sourcing group that is also working with the older factories to put make sure we put lean into that. As far as our options are concerned, where we're consolidating an awful lot of buying, we're seeing reductions anywhere from 5 to 12 to 13% as you normally would expect. And not using the auctions, just doing negotiations we're still negotiating some pretty good reductions. So overall the strategic sourcing operation has done a very, very good job. And they continue to do a good job.

And driving lean and continuous improvement, one of the things we're focused on, it all goes back to human talent. We're increasing the number of black belts and green belts in this company as quickly as we can.

At this time there are no further questions. Do we have any closing remarks?

I would like to thank everyone for joining us. We have a lot of great events for the rest of the year, so we look forward to seeing you soon. Hope you all have a great day.

Thank you for participating in today's conference. You may disconnect at this time.