福斯 (FLS) 2012 Q2 法說會逐字稿

Welcome to the Flowserve Q2 2012 earnings conference call. My name is Kim, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session.

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 two 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 presentation 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've 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 US 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 remains, 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 make progress shipping low-margin legacy backlog, which was taken in the competitive environment of 2010 and early 2011 as the groundwork for our aftermarket business. We've also seen a continuation of the dollar strengthening since the end of the first quarter and expect additional earnings headwind as a result.

Mike will outline the expected impacts from legacy backlog and currency for the rest of the year when he updates you on our current guidance.

Turning to our capital structure, we took additional actions in the quarter to increase the efficiency of our balance sheet and ultimately increased value for shareholders. Based on our consistent performance through the cycle of the last few years and a demonstrated cash generating generation ability of the business, coupled with our improved visibility and our strengthened end markets, we concluded it made sense to increase the efficiency of the balance sheet and capture the value that additional leverage would provide to our capital structure.

Our Board approved a targeted capital structure with a gross debt level of 1 to 2 times EBITDA compared to our prior gross debt level of 0.7 times. We decided that the best use of the cash generated from this higher leverage was to increase our share repurchase authorization to $1 billion. We intend to complete this share repurchase program during 2013.

We also initiated a $300 million accelerated share repurchase program under this $1 billion authorization financed with short-term borrowings to systematically repurchase shares and to more quickly bring our debt level into our new targeted range of 1 to 2 times EBITDA.

We are very pleased that all three rating agencies recently upgraded our debt rating to investment grade upon our announcement of this new capital structure strategy. We are now well positioned to take advantage of the current attractive debt markets as we progress towards our targeted capital structure.

Move to the second quarter-financial highlights, I'm pleased with our 12.5% earnings improvement over last year, particularly in light of significant above and below the line currency headwinds of approximately $0.38. Second-quarter profit bookings were solid as we continued to capitalize on our investment in our end user strategies and localization, resulting in strong aftermarket bookings in the quarter of $508 million. Our focused and disciplined investments through the downturn have enabled us to create a current $2 billion annual run rate aftermarket franchise. We don't take this opportunity for granted and recognize that every day we must earn the right to support our customers.

The second-quarter also highlighted the strength of our diversified regional exposure. Weakness in Europe and softness in the Middle East were more than offset by strength in North America and Asia Pacific. We have seen this theme play out before. Our diverse regional and end market exposures, together with our strong aftermarket franchise, provide the Company with a lower net risk profile, which we believe is a key differentiator.

Looking forward to the balance of 2012, we are keeping a close eye on Europe. However, I continue to be cautiously optimistic about how the cycle is progressing.

Quoting activity has been above 2011 levels, and while uncertainty in Europe caused the timing of some projects to shift, this increased activity should result in increased booking opportunities in 2013 and beyond. While we are optimistic about these future large infrastructure projects and their aftermarket potential, we will continue to focus on areas where we have greater control, including operational initiatives, driving our end-user aftermarket strategies and the pursuit of small-cap run rate projects, while we wait for the large projects to work their way through the approval process.

So, with that, I'll turn it over to Tom.

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 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 six 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 in 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 continued 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 US.

From a power standpoint, economic development and environmental regulations remain the primary drivers.

China and India continue to utilize a broad range of technologies, including nuclear and fossil.

Recently, the nuclear market advanced another step as China approved its safety plan after a nine-month review.

Interest in renewable energy is growing in new areas -- for instance, solar generation in the Middle East. In the water business, we still see opportunities in China and the Middle East.

Finally, we are seeing substantial opportunities in fertilizer production worldwide.

Turning to the year-to-date sales regional mix, we grew the top line by 6.3% or 11.5% on a constant currency basis. Strong activity in North America and Asia Pacific more than offset weakness in Europe.

In North America, investment in pipelines, terminals and storage facilities continue to rise to move to newfound oil and gas. In China, investment in LNG facilities increases as a means to supplement long-term energy concerns, while the Middle East continues to drive for industry diversification with mega investments in power, refining, petrochemical and water sectors.

Finally, recent large oil and gas discoveries in Latin America are attracting increased attention for additional investment activity.

Now I would like to turn to our segment results for the second quarter. The Engineered Product division increased bookings $15 million to $603 million, up 2.5% or 10.2% on a constant currency basis.

Aftermarket bookings increased $27 million, up 8% or 13% on a constant currency basis. I am pleased with the strong aftermarket growth rates, resulting in a book-to-bill of 1.08, reflecting our successful end-user strategy. We continue to invest in our aftermarket capabilities, adding an additional QRC in Africa in the first half of the year.

Bookings growth was driven by the strength in the general, oil and gas and chemical industries, partially offset by weakness in the power industry.

Regionally, we saw increased bookings into North America and Asia-Pacific, partially offset by decreased activity in Europe and the Middle East/Africa.

Sales increased $29 million to $587 million, up 5.3% or 13.2% on a constant currency basis, driven by increased customer aftermarket sales with increased sales into the Middle East/Africa and Latin America, partially offset by a decrease in Europe.

Gross margin declined 110 basis points to 33.4%, negatively impacted by shipments of lower margin legacy projects, partially offset by a sales mix shift to the higher-margin aftermarket business and the effects of lower costs associated with operational execution improvements. Operating margin improved 60 basis points to 16.2%, due primarily to the lower SG&A and increased gross profit.

We continue to improve our business processes and operations to drive quality and on-time delivery. Employee training and lean processes, Kaizen events, and value stream mapping are expanding throughout the organization.

Additionally, focus site initiatives designed to improve on-time delivery and reduce past-due backlog are driven by division level teams of master black belts, quality managers and supplier development. The division teams stay engaged with the site to ensure all projects are completed.

Finally, we have a rigorous program in place for supplier qualification, development and management.

The Industrial Product division's bookings increased $14 million to $243 million, up 6.2% or 11.8% on a constant currency basis, driven by activity in the general and chemical industries. Bookings strength in Asia Pacific and North America was partially offset by weakness in Europe and Latin America. Sales increased $7 million to $232 million, up 3.2% or 9.4% on a constant currency basis. Strength in North America and the Middle East/Africa and Asia Pacific was partially offset by a decrease into Latin America. Both original equipment and aftermarket sales were up 3% versus prior year, or up 9% and 10%, respectively, on a constant currency basis.

Gross margin increased 440 basis points to 24.1%. Gross margin improved 110 basis points, excluding the impact of $7.5 million of realignment charges in 2011 that did not recur.

The improvement reflects continued traction on the IPD operation improvement plan as we focus on operational excellence, on-time delivery, supply chain and cost management. Operating margin improved 600 basis points to 10.3%. Operating margin increased 250 basis points, excluding the impact of 2011 IPD realignment charges that did not recur on strong SG&A leverage and disciplined cost management.

I am pleased with the progress we have made on the overall initiatives to improve operating margins. Strong SG&A expense control, disciplined pricing policies, strong project management and improved spend leverage have driven the steady improvement in our operating margins. I am confident we are taking the necessary actions to reach our targeted operating margin of 14% to 15% by 2015.

The Flow Control division bookings decreased $28 million to $412 million, down 6.5%, or relatively flat on a constant currency basis, on a particularly tough compare.

The second quarter of 2011 was FCD's highest booking quarter ever. While most of the end markets were down, again on a very tough compare, the power market was strong. Regionally, strength in the Middle East/Africa and North America was not enough to offset a significant decline in Europe. Sales increased $14 million to $402 million, up 3.7% or 11% on a constant currency basis, versus a very strong 2011 compare.

Sales growth was driven by original equipment sales in the oil and gas and chemical sectors, primarily in Asia Pacific and the Americas.

Regional strength in Asia-Pacific, North America and Latin America was partially offset by Europe and the Middle East/Africa. Gross margins declined 110 basis points to 33%, due primarily to a mix shift to original equipment, reflecting the shipment of certain low margin projects in oil and gas, strategically bid in early 2011 to build our aftermarket base in the sector.

We have continued to drive the oil and gas business in the Middle East through portfolio enhancements and QRC development. Operating margin decreased 50 basis points to 15%.

Disciplined cost control drove SG&A as a percent of sales down 70 basis points to 18.1%.

FCD continued to develop its aftermarket capabilities with the addition of two QRCs in China and Russia in the first half of the year. The new sites will support our customers with local inventory, manufacturing capability and quick response requirements.

Overall, I'm pleased with the operational improvements since the "One Flowserve" initiative began. Work remains, and we continue to drive internal efficiencies and focus on further improvements in the front-end bidding and project pursuit processes to drive quality improvement in our backlog and margin expansion in future quarters.

And now I would like to turn it over to Mike Taff.

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% on a constant currency basis.

Overall, gross margins declined 30 basis points in the quarter.

As we discussed at the end of Q1, we expected gross margins to face continued pressure due to the shipment of some large, low-margin, legacy backlog projects booked during the downturn in 2010 and the first part of 2011.

Similar to Q1, there were approximately 100 to 200 basis points of impact due to these low margin projects flowing through earnings, and we expect this to continue in Q3.

One large project, [Yamboo], booked in a very competitive environment in the first half of 2011, accounts for a significant amount of the legacy backlog expected to ship over the balance of the year. We were sole-sourced and expect the facility to provide 30 to 40 years of very attractive aftermarket opportunity. We expect to see gross margin improvement in the fourth quarter as the majority of these legacy, low-margin projects are expected to be shipped by the end of the third quarter.

SG&A expenses as a percentage of sales decreased by 180 basis points to 18.9% for the quarter on strong leverage and a continued focus on cost management. Excluding the favorable impact of a $3.9 million benefit on the resolution of certain items, sales grew as a significant multiple to our SG&A growth, even as we continued to invest in our QRCs and engineering capabilities in emerging regions. Operating margins for the second quarter were up 150 basis points to 13.9% or up 70 basis point excluding realignment charges in 2011 that did not recur.

In the other expense income line, the stronger US dollar continues to impact reported results.

Similar to the first quarter, we recorded an $0.11 loss below the line as we marked our hedges and balance sheet items to market, whereas last year we saw a $0.07 gain resulting in a negative $0.18 swing.

We also saw roughly $0.20 of negative above the line translation impact. That is a $0.38 year-over-year delta in the quarter and $0.62 year-to-date.

Our effective tax rate for Q2 was 26.7%, was similar to Q1, is slightly below our stated structural rate of 28% to 30%. We continue to expect the full-year rate to be in the 28% to 30% range, possibly trending towards the lower end of the range, including discrete items.

Turning to cash flows, we had a strong quarter generating $168 million in operating cash, reflecting significant improvement on both a quarterly and year-to-date basis. CapEx was $28 million in the second quarter, about $4 million higher than last year, as we continued to increase our aftermarket capabilities, adding an additional QRC during the quarter, a total of three for the year, all in emerging regions. Our capital expenditure outlook for the year remains in the $125 million to $135 million range.

As part of our capital allocation plan, which started last fall, we announced a new targeted capital structure of 1 to 2 times total debt to annual EBITDA, as we move towards a more efficient balance sheet. Our improved end markets and proven ability to manage through the cycle gives us the confidence to prudently increase leverage, while driving improved cash utilization efficiency and investing capital in the most accretive opportunities available.

As part of our plan, we executed a $300 million accelerated share repurchase program to systematically access the market over a six-month period. We believe our targeted capital structure will provide adequate flexibility to meet our commitments to shareholders while maintaining flexibility to be opportunistic when unique investment opportunities arise.

Bolt-on acquisitions will continue to be focused around strategic fit and revenue synergies across our global sales and aftermarket platforms with significant consideration of integration risk.

During the quarter, we paid a total of $411 million related to share repurchases, partially financed by $300 million of short-term borrowings. We took delivery of 3.3 million shares, including the initial delivery of 2.26 million shares for $240 million under our $300 million accelerated share repurchase program initiated in June. While the cash has been paid, the remaining $60 million share value under the ASR program will not be settled until the conclusion of the program later this year.

As of the end of Q2, we have $625 million remaining on the $1 billion program, including the impact of the final settlement of $60 million of share value under the ASR program. As it relates to dividends, we increased our dividend over 12% earlier in the year, and returned $20 million to our shareholders in the second quarter or $37 million year-to-date.

Moving to working capital, we made some progress but work remains. As it relates to receivables, DSO decreased seven days versus the first quarter to 81 days. I remain confident that with our disciplined focus on cash collection and the improvements we are making on the front-end bidding process, we can drive DSOs into the mid-60s over the next 12 to 18 months.

On the inventory side, we successfully decreased our past-due backlog by approximately 200 basis points since the beginning of the year, which puts us back near historical levels.

With the implementation of operational improvements and Tom's focus on on-time delivery and cost of quality, we believe there is additional opportunity to reduce that past due balance and drive further inventory efficiency.

Although we saw improvement in our inventory turns up to 2.8, we believe we can hit a long-term target of 4 to 4.5 turns over the next 18 to 24 months. We have a number of internal initiatives ongoing around working capital, and as I stated previously, working capital is receiving a significant amount of my focus as we bring these metrics to more appropriate levels.

So let's take a look at our outlook for the remainder of 2012, following a solid first six months.

Similar to the prior years, we expect the third quarter to be seasonally challenged from a volume and absorption standpoint.

Additionally, as we mentioned earlier, the third-quarter margins will be impacted by legacy backlog shipments by 100 to 200 basis points year over year. However, the fourth quarter is shaping up to clearly be our strongest of the year.

From a foreign currency perspective, we have seen significant volatility. With a strengthening US dollar, we are now estimating approximately $1.00, instead of the $0.50 in prior guidance, of negative foreign currency impact above and below the line versus 2011. Most of this additional impact will be felt in the second half of the year.

Third quarter will be a tough year-over-year compare as the dollar begins strengthening in the fourth quarter of 2011. We expect additional foreign-currency headwinds will be partially offset by the share repurchase activity as we execute on our share buyback program. We estimate approximately $0.30 of net benefit related to share repurchase activity in 2012, offset by higher borrowing costs related to increased leverage.

With the recent credit upgrades from the rating agencies, we anticipate taking advantage of current attractive debt markets to further support our capital structure strategy. Net net, despite the significant incremental foreign-currency headwind, partially offset by our share repurchase activity, we remain confident in our initial guidance range, therefore reaffirming our 2012 full-year guidance of $8.00 to $8.80 per share.

And now let me turn it back over to Mike.

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

(Operator Instructions). Charley Brady.

Thanks. Good morning, guys. 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, 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 have actually seen nuclear start to free up a little bit, and we have seen a 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 in the mining industry, you've seen continued feed work. That's been the case for about the last two years.

All right. And your commentary on the fertilizer production opportunity, can you go into that a little bit more? 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 a 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.

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 will vary from time to time. I mean I think one consistent theme that we've talked about is you have 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 and I'll get back in the queue here. What is the new share count assumption embedded in the current guidance for 2012?

Hey, Charley, it's Mike. I mean I think the best way to think of that is for the year we purchased about $433 million worth of shares, and by year end we would expect that number to increase another $200 million to $240 million or so by the end of the year.

Great. Thank you.

Scott Graham, Jefferies.

Yes, good morning. Can you hear me?

Yes, we can, Scott. Good morning.

Great. Thank you. I was just wondering, maybe this is a question for Mike, then one for Tom and then hopefully, Mark, one for you.

Mike, the cash flow profile of the Company has improved two 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 to 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 have had good success. That will correlate to working capital, the utilization of working capital.

So it's really been around a lot of the operational improvements. We still have work to do on the working capital, but that's driven some of the cash conversion.

All right. Thank you. As far as -- so, Mark, maybe they'll just stay with you.

The legacy backlog, I guess, it's frustrating from an outsider standpoint that this thing just 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 really works.

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 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, it's very strategic; we're very happy about it, sole-sourced in the western region of Saudi Arabia. We'll 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 are long-cycle projects, so we anticipated it, we will work through them. Sometimes these things do push if the customer is not ready, but for the most part, we will 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 and 2011. We talked about some of the additional bidding activity that we see in 2013 in 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 the improvement in our gross margins, improvement in our operating margins, focus on leverage. So this is the way we kind of cycle through in our business.

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 pushbacks of deliveries. Is that fair?

You can have the customers -- look, one of the things on these big projects we 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 out 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.

All right. Fair enough. The other question I had was for Tom.

Tom, your work across the segments, I am just kind of wondering -- I asked this question last quarter, but now we 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 in the proposal space, so we're putting a lot of effort into the proposal and, in terms of the setup as a scope on the job, the setup 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 stage. 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 lien. 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 two items are items we've 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 quality 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 continued to drive. We just had, I would say, a more rigorous program for driving those initiatives.

Understood. Thanks very much.

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 four 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-priced cycle in 2007 and 2008. We spent a lot of time realigning what I'd call the front end of our business in 2009, 2010, 2011, 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.

Thanks very much.

Kevin Maczka.

Thanks. Good morning. 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 megaproject push-up.

So two questions. I guess, on the short cycle side, has been stabilized at this point? Any moderation that you've seen? And on the megaproject 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 let in 2013 and not just pushed out even further if things remain tough?

Okay. Well, a couple 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're 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 long cycle and 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 will come online, but they can push out a couple of quarters, especially when the world pauses to see what happens in Europe.

What gives us confidence that they will 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 are 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 see is the impact of elections in Mexico, and then there's a new leader at Petrobras. Doesn't mean they're not 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 independents, 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.

Got it. And then, Mark, environmental regs is another area that we haven't talked as much about, but you mentioned it a couple of 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 are always needle movers, but if you look at how diversified we are across, for example, the hydrocarbon oil and gas business, LNG has certainly a needle mover. But in and of itself, 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 toward 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 will be caught on the other side.

So there is a view, globally, that they're going to stay diversified in their power sources. We fundamentally believe nuclear is going to remain 20% of the global supply of power, but you do have regulatory issues.

Fossil, 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 reevaluation mode, but there are also starting to invest again. So we'll always have these things 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 hydrocarbons.

Okay. Got it. Thank you.

Mike Halloran.

Good morning, everyone. Some thoughts on leadtimes and 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 are seeing in your plants and try to compare that to the industry.

I may not have heard the last one, somebody will tell me, but leadtimes, you've seen 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 leadtimes.

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 leadtimes really GAAP out was in 2007 and 2008 when the entire supply base was getting constrained and the E&Cs recognized that they were going to have to flex out on leadtimes.

And the second part of the question was just utilization levels, how they're trending in your facilities, and then maybe try to give a comparison.

Yes, no, good question. Mike, we talked about -- I'll give you an industry perspective, in 2009 and 2010, you had capacity that came on that was planned in 2007 and 2008, and there was capacity that was certainly chasing price at that point in time.

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 is starting to getting incrementally utilized in our business, and as these projects come online, it will start to get utilized, and that is when price will start to rationalize that capacity.

Yes, that makes sense here. Appreciate the time. Take care.

Robert Barry, UBS.

Hey, guys. Good morning. 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? (multiple speakers)

There's three factors 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 look at our fixed cost absorption, Q1 tended to be our lowest historically and Q3 was our second lowest.

So there's always been that element around the more joined 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 will focus on within our control -- costs, improving the IPD platform that we talked about, and operational enhancements, a lot of things that we are going to work on. But I think we just want to give you a general sense that remember the seasonal element around Q3. Also, we're working through the cycle and with some of the legacy backlog as you look at our margin profile. But it's certainly important to us.

Yes. 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 it last year. We said, look, we're going to be living with the downcycle through a good part of 2012. That's just the way our business works.

Like I made the comment earlier, because of the leadtimes, earlier to Mike's question earlier, the leadtimes back in 2008 -- we were able to live with what was very high-priced backlog for about two years. And so, this is the offsetting impact as we work through the cycle as well, but we would anticipate it.

The other comment we made in the beginning of the year was around our past due, and we 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, and 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 as sustained 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. They look way past the spot price of oil.

Yes. Okay. Well, that's encouraging. Thanks a lot.

Hamzah Mazari, Credit Suisse.

Thank you. 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 COO structure that you've put in place?

Okay. Well, I mean I think the way we generally look at cash employment is, what is the best return for our shareholders in terms of how we deploy cash?

So if you think, for example, I'll highlight on the capital structure -- it was really around, as we move 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 it 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 on 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 have to have good strategic fit, and that is what you've seen, for example, in Valbart and Lawrence, that we can leverage our sales organization, drive through our aftermarket capabilities, 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'd finance it. But it's really going to start in terms of what is going to be the cash-on-cash return of the investment 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.

That makes sense. And then just a question on the legacy backlog. You guys spoke of that being a margin drag, 100, 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 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.

And the way to think about the legacy backlog, Hamzah, we've talked about this -- on our long-cycle business, which has historically been 20% of our business, think back about 2007, 2008, and also consider that on these big, big projects, 40%, 50% of that project is something we buy from other companies. A big driver, a big motor. 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 2007, 2008, 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 what we saw in 2010 and 2011 and people were looking to cover their absorption, cover their variable costs, 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 to 2012, what you see is you can get good margin on the equipment you manufacture. You can 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 businesses.

So what we're seeing is the market starting to move back to more normal levels. And typically what you'll see is it will undershoot in the downcycle, and it will overshoot if capacity gets real tight.

That makes sense. And just the last one from 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, 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 are aware of 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 one thing that -- 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 a lot of this legacy backlog is directly related to feeding that aftermarket business in future periods.

That make sense. Thank you.

William Bremer, Maxim Group.

Morning, gentlemen. Nice quarter, given your end markets. Question -- bookings. Quite impressive on your bookings, given the fact that you had really no large or you call that 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, say, shorter cycle.

Yes, I think it is 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 has improved. And in that, 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 gives us confidence that what we are 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 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 of some of the realignment activities and everything we had, yes. If you look at the business in terms of backlog flowing through and backlog flowing through, it's 100 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 the mix shift there, but has there been any legacy projects or, let's 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 the 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 is you look at in terms of our capabilities, broad capabilities, on some of these big projects, we were able to get our pumps, seals and valves on them.

Thanks, gentlemen. I appreciate it.

Jamie Sullivan, RBC Capital Markets.

Good morning. Just to clarify the last question on margins, you had have the 100 to 200 basis point headwind, but it doesn't necessarily mean that margins will be down year over year. Looking at Q2, you had the headwind, but margins were down. Is that the way to think about it?

Well, we've got the headwinds. Like you saw in the second quarter, we were 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 has come through that was booked in the downturn for aftermarket business going forward, and sometimes it was to load the facilities.

The other things will continue to drive margin improvement overall in the business -- cost controls, better flow through in 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 three or five 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 five, six 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 has become increasingly complex. And so oftentimes they want the OEM to service it.

You also had the other dynamics that a lot of their capability is for repair to the customers, which is probably our biggest opportunity, you are seeing a rotation in retirement there, or a redeployment oftentimes to other parts of the facility.

So we've certainly seen better capture rate, but you've also seen the benefit of an 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. It'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 growing at the rate it was, because there's just not much that 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 business businesses across the segments.

That was one of the areas of growth overall in the business imparting 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 their infrastructure in the business.

You would look behind the spend in China, that you still have the issue where people are moving to major cities and require more power. You still have more cars on the road 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 would call, very, very short cycle. And a lot of our short cycle business, keep in mind also, is replacement. So these facilities need to continue to operate.

I would tell you the same thing in Europe is that 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.

Thanks very much.

Brian Konigsberg, Vertical Research.

Yes, hi, good morning. 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 discuss how that will flow through?

From what I understand, it's kind of hedging against the mismatch between products sold or produced in the European region, but may be 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 them 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 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 has seen 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 took put the notional, it's really sitting on backlog, if you put the notional amount on an order that is in backlog that stays there for four quarters, you are 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 will 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 to 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 on the projects, the three to six 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 four to six quarters.

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

I don't think it's going to tip the needle either way. 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.

Got you. Thank you very much.

John Moore, CL King.

Good morning, everyone. 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 one or two items you can point to operationally that are performing better than you had originally anticipated?

Well, a couple of things. We haven't changed the indication around our topline. We had a 5% to 7% range. We had laid that out I think in earlier periods, and it hadn't changed at this point in time.

But I think what you do see is we have been able to offset this, and some of it is the traction that Tom is getting overall in the business and the focus on cost 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 $1.00 is a significant impact volatility and currencies can have on 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.

Okay. Got it. I guess the 5% to 7% range, I'm interested to hear that you are 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 stronger. 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.

Okay. Got it. Just final question then. The IPD orders this quarter, I thought those were actually pretty strong given what's going on here in the global economy, and that does seems 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 US?

I think they are certainly benefitting from some of the trends overall you're seeing in what we call the shorter cycle businesses, also benefiting from some of the 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 you again -- it doesn't mean no growth. It just means, for example, in 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'll go back to what we said four or five 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.

Thank you.

David Rose, Wedbush Securities.

Good morning. I'll just go with two 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 two 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 are 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 of years hold very, very tight on that corporate costs; continue to do that as well.

So it's a lot of things that we are driving, but it's really more around driving leverage in our business over the next couple of 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 growth our aftermarket business. Take advantage of the opportunity of some of the long-cycle business and leverage our SG&A. All of 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 to 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 comment is 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 are 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, 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 are always striking a 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?

I think the number we provided, if I recall correctly, 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 base or a contract, we must earn the right to serve our customers every day, and so we don't get overconfident in the fee base.

What that does indicate, though, and we are seeing them increase, is how customers move strategically around total cost of ownership and lifecycle costs. 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 focus on maybe parts, service and repair. Increasingly, customers are now thinking about the operation of their facility over five to 10 years, and that's where we're starting to pick up some of these fee-based opportunities.

Okay. Great. Thank you very much.

Charley Brady.

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

Say again?

What was the fully diluted share count at the end of the quarter on June 30?

Shares outstanding on the face of the queue is 51,129. The weighted average was 54,266.

But the 51,129, that's as 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 are reflected in that.

That's correct.

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

That is the one he just gave you that was on the face of the document. 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 queue is what will carry forward, starting on July 1 into the back half of the year.

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

Yes, so, in July? We are continuing with them, but we will disclose that as we close out the quarter. I think what Mike talked about is relative to where we were in the program at 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 discrete corporate items, there was a benefit. What exactly was that?

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

Okay. Thanks.

[Stuart Sharp].

Good morning. 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 4 and 4.5 turns?

Yes, Stuart. Mike. Yes, I think in the queue 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, I'd roughly say, another $50 million to $100 million or so of monetization there potentially in all.

What was 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 an 18- to 24-month period.

Okay. Thank you.

Thank you. This concludes the time we have for our question and answer session. I will 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.