福斯 (FLS) 2014 Q2 法說會逐字稿

Welcome to the Q2 2014 earnings conference call. My name is Richard and I will be your operator for today's call.

(Operator Instructions)

I will now turn the call over to Mr. Jay Roueche, Vice President, Treasurer and Investor Relations.

Thank you, operator, and good morning, everyone. We appreciate you participation today as we discussed Flowserve Corporation's financial results for the second quarter of 2014, which we announced yesterday afternoon in our press release and Form 10-Q filing. Joining me on the call this morning are Mark Blinn, Flowserve's President and Chief Executive Officer; Tom Pajonas, Executive Vice President and Chief Operating Officer; and Mike Taff Senior Vice President and Chief Financial Officer.

Following our prepared comments, we will open the call up to your questions and instructions will be given at that time. Before turning the call over to Mark, let me remind you that this event is being webcast and a slide presentation is available. An audio replay will also be accessible approximately two hours following the conclusion of this live call.

Please also note that this call and the associated earnings materials contain forward-looking statements that are based upon forecasts, expectations, and other information available to management as of July 24, 2014. These statements involve numerous risks and uncertainties including many that are beyond the Company's control. And except to the extent required by applicable law, Flowserve undertakes no obligation and disclaims any duty to update any of today's forward-looking statements.

We encourage you to fully review our Safe Harbor disclosures contained in yesterday's press release, slide presentation, and our Form 10-Q as well as our other filings with the Securities and Exchange Commission for additional information. All of these documents, including the live webcast and replay, are accessible on our website at Flowserve.com in the Investor Relations section.

I would now like to turn the call over to Mark Blinn, Flowserve's President and Chief Executive Officer for his prepared comments.

Thank you, Jay, and good morning, everyone.

I am pleased with our second-quarter results and our earnings of $0.90 per share. This performance keeps us on pace to deliver our full-year target. Additionally our quarterly bookings of nearly $1.4 billion highlight our growing aftermarket franchise and run rate business, and the beginning of some mid to larger OE awards.

Our solid bookings included over $530 million of aftermarket, and we increased backlog to $2.85 billion, up 11.5% or over $290 million since year-end. This increase level of order supports our outlook for near-term revenue growth. As a project cycle commences, we expect to see the traditional pattern where longer lead time products are awarded first benefiting our EPD and IPD segments, both of which realized nice bookings growth in the second quarter.

With our key energy markets expanding, we will maintain the discipline and selectivity that has served Flowserve well, and leverage our geographic diversity and pursue emerging regions with a cautious eye towards volatile regions such as Russia, Middle East, and Venezuela. Our employees' commitment and dedication is the cornerstone of our performance. We're gaining traction with our performance culture initiatives while making a high level of engagement and customer focus. Their efforts have delivered another quarter of solid financial results and enhanced our operational performance, which provides the opportunity for an increased focus on growth both organic and M&A while continuing to meet or exceed customer expectations.

Sales came in below our expectations this quarter, however, this was largely timing related including some delays due to customer change orders and delayed inspection. Mike will cover our financials in detail, but we remain confident that the second quarter's increased backlog will drive revenue growth in the second half of the year. During the second quarter and really year-to-date, we have delivered improved margin performance. Each segment during the second quarter generated increases in both gross and operating margins. This performance highlights the benefits of our disciplined and selective bidding process combined with our operational improvements and ongoing cost control focus.

We have made a number of margin-related commitments during the last few years. One was to increase operating margins by over 150 basis points above 2011 levels. We've now delivered four consecutive quarters above this threshold, even reaching the upper end of our stated range. While we recognize margins can and will vary quarter to quarter, we have made significant progress on this target over the last 2.5 years and it forms a solid foundation for the future.

A key component to our recent margin improvement continues to be driven by the IPD segment. As we have discussed over the last few quarters, IPD has made significant progress improving its operating platform. This quarter's operating margin of 13.3% is closing in on the 14% to 15% target that we established several years ago, and we remain committed to achieving this target by the end of 2015. To continue the margin progression at IPD, we have shifted its emphasis towards growth, and its 14.5% increase in bookings during the first half of 2014 is an excellent start.

Returning the focus to our total bookings, the $1.38 billion level this quarter was an increase of 12.6% year-over-year. We're also pleased that aftermarket bookings continued its positive trendline, up over 5% this quarter; but the impressive original equipment order growth of nearly 18% really moved the needle. The original equipment awards were a combination of a few large and midsize awards and strong recurring run rate orders.

First half aftermarket bookings of over $1 billion in 2014 represent a 6.7% increase year-over-year and highlight the success of our ongoing commitment to end-user strategies and supporting our customers. This consistent aftermarket business, combined with solid run rate activity, provides stability as the expected ramp-up in project awards begins to take hold.

We are very encouraged that this quarter's overall bookings growth occurred across all our end markets and in every region. We believe this indicates an acceleration of project activity that supports our growth plans. Tom will speak to our end markets in greater detail; but looking at our business by region, following a few years of reduced activity, the Middle East rebounded impressively with bookings growth of 20% in the first half of 2014. After Europe showed signs of stability in 2013, we were pleased that this region's bookings growth was nearly 16% year to date. while North American bookings increased nearly 6% supported by strong chemical and oil and gas production.

Latin America continues to face political and financial headwinds, but we're encouraged by modest bookings growth in the second quarter as well as by recent actions in Mexico to increase oil production. Finally, Asia-Pacific continues to be a focus area as our strategy is to further increase our presence and market penetration to support growth. As we move into the second half of the year, we are supported by an increasingly efficient operating platform and opportunities in our key energy markets both of which are expected to continue.

I'm confident that our strategic actions taken over the last few years significantly improved our capabilities and operations around the world. These improvements will enhance our attractiveness to clients for new work; and while I am pleased with the demonstrated operating progress we've made across our segment, I am equally encouraged by the potential for further improvements. We are committed to capitalizing on our opportunities to drive profitable growth and deliver shareholder value.

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

Thanks, Mark, and good morning, everyone.

The second quarter and first half results have largely rolled out as we anticipated. As Mark mentioned, we did incur some larger shipment delays as customers deferred inspections or issued change orders. This just impacts timing.

Improvements of both our bidding process and our operating platform continue to drive our strong margin and earnings performance. I believe after several quarters of talking about it, we now see the acceleration in our energy markets beginning to occur as evidenced by our strongest quarterly bookings level in over six years. It is also worth highlighting that this quarter's activity is even more substantial considering that currency, commodity, and pricing levels were much more favorable back in 2008.

In terms of our segments, EPD and IPD rove the growth as pumps tend to have longer lead times and thus, tend to be leading indicators. FCD bookings were actually down for the second quarter, but this reflects the general lag between the pump and the valve business. We expect FCD bookings to follow the leading indicators. And the valve sale in Q1 2014 also impacted the Q2 compare by about 3% on orders and revenue. While larger original equipment project activity is important for our long-term growth expectations, our run rate original equipment activity and consistent aftermarket business continue to provide a stable earnings platform.

I'm particularly pleased with our aftermarket performance. The second quarter of 2014 represents the third consecutive quarter with aftermarket bookings exceeding $500 million. And the last quarter was the first time we had delivered two straight quarters above that amount. I truly believe we have taken this recurring higher-margin business to another level. Considering its attributes, this business will remain an area of emphasis.

We continue to make disciplined investments in our aftermarket footprint including the new QRC we opened in Asia-Pacific this quarter. As we prepare for the building cycle and larger project work, I'm confident that we are and have been focused on the right areas to capitalize on this opportunity through superior execution. Even after making significant progress over the last few years in our One Flowserve another initiatives, we continue to believe significant propensity for further improvement remains.

Among others, these include operational excellence, ongoing focus on the cost of per quality and on-time delivery, customer focus and localization investments, development of a performance culture, and investment in global project management expertise. The consistent margin improvement we have delivered over the last few years reflects the success of our operational initiatives, and this quarter's strong gross and operating margin improvement in all segments further validates our strategies.

Now, looking at our end markets. Oil and gas activity was strong in the second quarter with bookings growth over 25% and a positive long-term outlook. We booked our first Ebullator order in North America this quarter since 2008. Ebullators have the longest lead time among our rotating equipment, which makes this award a positive leading indicator for upcoming refinery activity.

North America activity continues to be driven by pipeline construction, refinery upgrades, gas processing, oil sands development, and gas to liquid plants. This being on account of favorable natural gas and oil supplies. Additionally, continued opportunities exist in LNG facilities particularly in the US as projects progress through the regulatory approval process. Recent approval of condensate exports from the US may support additional production.

We also continue to expect new refining investments in the Middle East and Asia. These refining investments plus those in other regions will likely challenge the European refining market. Europe is however expected to increase diesel production. Brazil is proceeding with FPSO development. Longer-term opportunities in Mexico should increase following their recent policy reform intended to increase production levels.

From an oil and gas aftermarket standpoint, maintenance activity in the Gulf Coast continued the first quarter trend with increased bookings growth off the lower levels we faced previously. The chemical market also remains strong as new capacity investments in North America continue to advance including ethylene and ethylene derivative projects as the US has now joined the Middle East as the low cost feedstock leader.

Over the next decade, a 30% increase in US chemical production capacity is expected. In the Middle East downstream expansion efforts continue. Meanwhile, Asia and Latin America reassess their chemical development plans based on competing opportunities in the US.

Now moving on to the power market. We continue to expect growth. China, India, and Russia continue to pursue fossil-based projects. The Middle East also sees increased activities both in terms of conventional and solar power. North America and Europe however remains slower due largely to conservation, the lack of a consistent energy policy, and modest energy demand drivers. However, the low price of natural gas and recently announced CO2 reduction guidelines should continue to drive the US combined cycle market subject to pipeline capacity.

Nuclear power remains in transition, but we see continued development in China, Russia, and South Korea and discussions of new capacity in some regions of Europe. Following new safety standard requirements, Japan is moving closer to restarting a portion of its nuclear capacity, idle since 2011. Finally, natural gas combined cycle plants are a global opportunity. Strength in Latin America drove increased bookings in our water market, while strong activity in North America drove higher general industry bookings this quarter.

Wrapping up, I'm encouraged as we head into the second half of the year. My confidence is rooted in the accelerating energy markets we serve and our enhanced operating platform that is now consistently delivering solid results for our customers. We remain focused on growth, profitability, execution, the customer, and driving returns for all of our shareholders. With that overview, let me now turn it over to Mike Taff.

Thank you, Tom, and good morning, everyone. Following Mark and Tom's operational overview and business outlook, let me now discuss our financial results in greater detail.

With our solid results in the second quarter and first half of 2014, we are on pace to deliver on our full-year targets. Second-quarter EPS increased 7.1% to $0.90, and this amount included $0.03 of foreign exchange headwind, below the line severance, and realignment expense. In addition to the revenue impact of some customer driven delays mentioned earlier, we also experienced the effect from the Naval business sale completed last quarter, which will remain a headwind for the second half of the year as well.

Considering these factors and negative currency impacts on the first half of the year, we now expect revenue growth for 2014 to be in the lower half of our original guidance of 3% to 6%. I was particularly pleased with the gross margin improvement across all segments this quarter as operational excellence initiatives continue to take hold and our disciplined bidding process has demonstrated its impact in our current revenues as well as by improving the quality of our backlog, which will be recognized in future periods.

Our focused cost control was again evident in the SG&A line even as we continued to invest in our R&D, quality, and project management resources among other important initiatives. Our total SG&A expenses declined year-over-year in the second quarter even as it increased slightly as a percentage of sales. Our longer-term goal remains to reduce SG&A as a percentage of sales to the 18% range. I believe the programs we are executing and our ongoing cost focus, combined with the growing topline will enable us to achieve this commitment in time.

Operating margin of 15.9% is approaching the high end of our previously announced three-year margin improvement guidance of 15.2% to 16.2% by the end of this year and includes solid improvement across all business units. Additionally, IPD continues on track for its targeted 14% to 15% range by the end of next year. In addition to the higher quality work and operational excellence initiatives, we also benefited this quarter from a 1% mix shift towards aftermarket.

Below operating income, foreign currency had a negative impact of roughly $4 million in the second quarter versus a slight benefit last year due primarily to movements in the Brazilian, Mexican, and Singaporean currencies relative to the US dollar. We continue to work to dampen the impact of foreign currency volatility on our results and monitor FX closely as the strengthening dollar typically is a headwind. Our tax rate for the quarter was roughly 29%, consistent with our expected rate of approximately 30%.

Turning to cash flows, we generated $74 million from our operations during the quarter, similar to last year. We delivered a modest improvement in our year-to-date operating cash flows; and consistent with the normal seasonality, expect to generate a significant portion of our cash in the second half of the year, as we continue to work towards our goal of consistently generating annual free cash flow near our net income level. Major uses of cash in the quarter included share repurchases and dividends totaling $65 million, as we continue to return value to our shareholders.

Capital expenditures were $22 million, and we repaid $10 million of debt. Working capital remains a key area of focus but progress often feels two steps forward and one back. We currently are facing challenges clearing receivables on a timely basis in some emerging markets such as Latin America. While the customers in these markets have consistently paid their bills, the persistent delays in payment are negatively impacting our DSO. We're taking a number of corrective actions to improve the situation but it continues to take time and effort.

Inventory has increased due in large part to our growing backlog. Turns were relatively flat with last year, as we continue with operating improvement resulting in our third consecutive quarter with past due backlog below 5%. I remain confident that we're taking the necessary steps to achieve our targeted cash conversion levels and will continue to emphasize this area.

Moving to our EPS guidance and outlook for the second half of the year, we are reaffirming our 2014 earnings guidance of $3.65 to $4.00 per share following our solid first-half results, continuing operational improvement, and accelerating end markets. I think this far in 2014, we've demonstrated our ability to grow earnings even in a modest revenue environment through higher-quality revenues and exceptional operating performance. With our full-year revenue target now in the lower half of our original 3% to 6% guidance, it indicates we expect revenues will pick up smartly in the second half of the year from both increased activity levels as well as from the backlog we've increased year-to-date.

Turning to our capital priorities, as mentioned earlier we continue to return value to our shareholders and remain committed to our disciplined approach to capital deployment, including organic and inorganic opportunities. We will continue to invest in our business, to increase our capabilities in emerging regions, and our aftermarket strategies to deliver profitable growth; and as such, continue to expect CapEx in the range of $130 million to $140 million.

In summary, Flowserve's financial position is solid. We have a well-defined leverage and capital return policy. We're a strong cash generator and have sufficient capacity for growth investments. Much like other areas in the Company, we have opportunities for improvement and believe the expected turn in the cycle will prove beneficial for Flowserve and our metrics.

With that, I'll turn it back over to Jay.

Thanks, Mike. Operator, we have now concluded our prepared remarks this morning, and would now like to open the call for any questions.

Thank you.

(Operator Instructions)

Hamzah Mazari, Credit Suisse

Good morning. Thank you. A question on margins, and Mark you touched on sort of your margin target in the prepared remarks. Maybe if you could give us a sense of, how much of the low hanging fruit on the margin side is behind you? You've done a lot of realignment work, you have the One Flowserve initiative. Is it fair to say that the margin upside over the next couple of years will come more from mix with the aftermarket and potential pricing rather than the cost side? Just trying to get a sense of where is the upside on margins going forward, where does it come from?

Okay. Well, if you looked across at one of them is the fixed cost leverage on the G&A. If you think about it over the last -- in our year-over-year compares, we haven't gotten leverage like we did in prior periods because of the relatively flat revenue growth, so that's an opportunity on the fixed cost leverage side.

Moving up the P&L, you saw good improvement on the gross margin side but what I'll tell you Hamzah is we still have some work to do in some of our facilities so there's room for improvement there. I think we talked about in the Analyst Day, we're about halfway through where we need to be. It takes time to get the businesses running as efficiently as you want, and so there's still work to be done that will benefit the gross margin line as well.

And then continuing to look at what we call continuous improvement or realignment, we see there's opportunities where we have underabsorption, we've added new capacity in emerging parts of the world, that's very efficient capacity. So we're always going to have opportunities to drive additional margin through just continuous improvement and really looking overall at our footprint long term. And then you mentioned also the pricing environment.

So as you kind of move into these cycles, as we've talked about before, it certainly is competitive. We did -- we see it's still in front of us. What you saw this quarter was -- as Tom mentioned, some of the longer lead time products that we have really are what supported some of the mid-size and one sort of larger project that we took in during the quarter, but that certainly is still in front of us as well. So that's really how you drive the margins in the business; and I think, another thing is continuing to invest in our business in some of the products where we can command margin and drive our aftermarket growth. So we certainly have some opportunity as we look forward to drive margin in this business.

But as you know, what we like to do is when we have our commitments and Mike talked about them in his comments, we like to deliver on those and then we'll talk about where we're going from there.

Right and just a follow-up question. The second half sales ramp based on your guidance seems much higher than what you've seen in the second half on sales historically. I know you mentioned customer change orders and some deferrals. Do you have any sense of how we should think about your confidence level in the second half on sales? Is it possible to quantify what was deferred? Any color there? Thank you

Yes. We talk about where we are in the cycle, and I'll go back again to 2007 at 2008 just for edification. That was a period of time where sales were coming almost as expected because there was a big push to get these things in the ground and installed because of what was going on with the commodity prices and economies. And the other thing, frankly, I'll tell you is when execution isn't at the level where it is now in our company oftentimes we can become the gating item on a project. So with the improved execution, what we're able now to do is position these to be delivered to the customers, but it's really up to them as to when they want to take it.

The last thing they want to do is store a piece of equipment on-site for a period of time because it sits out in the elements. So that is not atypical from the cycle. So as we look forward, what we see is we want to make sure we're ready to deliver these things, if they need some additional changes to the process conditions or additional elements to it, respond to that, capture the value from doing that; but as we look forward, we do see typically Q4 is our biggest revenue quarter, has been historically in our business. We know these projects are moving forward. We are not the longest lead time product on it, so we know that there's a lot of work that's been done on these projects and they're going to get installed.

So that's how we look at it and when we do our revenue forecast going forward. I think what you heard in my comments is we expected little more revenue up to this point, but what has occurred doesn't surprise us.

Great. Thanks a lot.

Thank you. Scott Graham, Jefferies

Hey good morning

Good morning, Scott

Could you talk a little bit about the makeup of the 13% bookings growth? In other words, specifically by -- you had a couple references to longer lead time projects in the pumps side, which is obviously the business, so the product line that carried the bookings this quarter. Typically you are two to five, two to six quarters in terms of the monetization of the bookings into revenue. Has that -- is everything still the bookings -- let's say, what percentage of the bookings is still within that range and maybe this quarter what kind of felt outside of that range to a longer lead time?

Sure. And I'm going to do it intentionally, let me build from the bottom up because I think that's still an important way to look at our order book. We underline our bookings growth, a lot of it was mostly driven by our aftermarket and run rate business. We did see one order around the $40 million range, which represented about 3% in some of the longer lead time products that we talk about.

Keep in mind and I think we've discussed this before, Scott, those projects typically have percentage of completion accounting. So if you're looking at how those convert to revenues from engineering to installation, it will be in terms of how costs build up over that period of time as to how we'll bring that into revenues.

The other middle size ones weren't near at that level. So if you think about our order book and how it's built, it's been really still be based things that we've been talking about before the good aftermarket growth in the run rate business run rate can run two quarters to six quarters depending on the type of product, where it is in the project, what the lead time potentially is in that business.

Okay. So what I think I hear you saying is that the underlying -- a lot of the underlying bookings were the run rate business and whatever that number is. And then after that, you had the large order, which I'm going to assume what you mean by that is more than six quarters although because that's percent of completion, we'll see that beforehand; and then midsized orders, which would be maybe I assume more toward the four to six quarter territory.

The midsize ones especially, and Tom made the comment on some of the longer lead time equipment depending on where it falls within the accounting in terms of percentage of completion, but typically those are fairly expensive pieces of equipment. Those are long lead time so to your point, I think that's right in the range that you've talked about.

Okay. So fairly balanced bookings. Nothing that would make it so that the bookings that you had this quarter, this 13% uprising here is all 2016, it's going to be sooner than that for the most part.

That's fairly consistent and I think you've heard that from the market in general is the big project opportunities are still out there. What we saw this quarter was some of the longer lead times, typically our Ebullators; and the point to that is, those are good leading indicators. Keep in mind, by the time they are ordering a gas turbine or some of this longer lead time, there's a significant amount of investment that's already been made in the business so it gives us the confidence that these things are going to move forward.

Understood. Thank you. And the second question is, and I don't want to read too much into this, but there was some wording in the press release around acquisitions and divestitures not affecting the lower end of the 3% to 6% guidance or I should say noninclusive. Are you seeing an improvement in M&A possibilities? Are you contemplating more divestitures again? Is there something I should be reading -- am I reading too much into that or are things maybe a little bit more active?

I think -- well, let me kind of walk through it. One, that statement is made just because we don't know what we may execute during the year, and so what we want to do is say, here's our view at this point in time, it's January. We had Innomag at the end of last year and we made the divestitures early on this year. What you should expect around when we talked about realignment, divestitures, whatever it may be is continuous improvement in our business.

We want these things to earn the cost of capital and good returns for our shareholders; and if they don't, then they're probably better positioned in other folk's hands. That's the message I think we've been consistent on. The other thing to talk about, is we're adhering to our bolt-on strategy, but one of the things with the improving platform is we feel more confident in being able to bring things and put them on our platform because it's reduced integration risk, and it gives us the opportunity on the margin relative to where we were two to three years ago to certainly be more opportunistic but we're going to stay disciplined on it.

Nothing is really in a sense changed, except for as this platform improves, what we do is it gives us the opportunity to be more opportunistic on some of the assets that are out there. I can tell you, it's still competitive for these assets. That's just the way the market is right now. There's certainly a bid in flow control, and we just have to be mindful of that the we get returns for our shareholders.

Yes. Understood. Thank you, Mark.

You're welcome.

Charley Brady, BMO Capital

Thanks. Good morning, guys

Good morning, Charley

Hey just back to Scott's question on the backlog. I'll ask straight out, how much of the current or end of second quarter backlog gets recognized in the next 12 months?

You can look at our disclosures in our 10-K, and I don't remember what those numbers are, but typically in FCD and IPD there's a substantial amount well in the 90% that rollout within the following four quarters. And I think and I don't remember the disclosure, but it's probably around the same for EPD especially when you consider the original equipment aftermarket mix that's in the business. So a substantial amount of our backlog rolls out in the next four quarters; and going back to the aftermarket business, that tends to be shorter cycle over a couple of quarters, a bulk of that goes out during that period of time. Run rate is shorter cycle, and then these projects depending on their size and the lead times they will roll through in percentage of completion, but typically they don't get shipped for oftentimes over a year.

Right. Okay. Just wanted to clarify that. On the aftermarket side of the business, given the strength you've seen in aftermarket, can you talk about -- as you look at your installed base maybe update us on -- are you seeing a better capture rate on your installed base than you have a few years ago, or is it just a factor of, you have a much larger installed base and that's driving growth in aftermarket?

I would say capturing more of our installed base is an area of opportunity. We will be discussing that more and more over the next two to three quarters with you because we think that certainly is a big opportunity for us is to capture more of our installed base.

We have done some of that. What you see that can drive aftermarket a lot is our end-user strategies. Some of our what I would call consulting capabilities in a sense, and I don't mean we have a consulting arm; but we work with customers around efficiency and uptime. Because if you think about it, with energy costs where they are, the biggest costs our customers face is operating these facilities, so they're looking for efficiency.

So it's a whole set of strategies which have consistently driven this growth over a number of years, and the point to that is in good times and bad if we take good care of our customers, we can get growth in this business. So as you look at what can drive aftermarket, an opportunity for us is doing a better job of capturing our installed base in our business. I think we do a very good job in the mechanical seals businesses that we have, but certainly have an opportunity in the other rotating equipment and our valve business. And as we continue to deploy some of our end-user strategies, we think that will drive growth as well.

And also just one other thing and I know we talked about this in 2008 and 2009, with some of these projects as they come in oftentimes there are commissioning spares. Basically when they start up a new facility, there are spare parts that are required as you gin up or prime the system so that will be an opportunity as well.

Thanks and just one final one, your commentary on IPD kind of the shift in strategy there moving towards more of a growth orientation, can you just discuss that in a little more detail? What does that actually entail? What's the specifics on kind of looking at more growth and fixing the business from where it was?

One example was the Innomag acquisition that we made. Again, those are more opportunistic than anything else. Something that we mentioned during our Analyst Day is investment in the sales organization, making sure we develop products. For years we've been talking about the iso-chemical pump that we brought to market. So spending more money in those areas, and investing more in those areas to drive growth, because the one thing you've got to keep in mind going back four or five years, when execution isn't at the level it should be, it's difficult for a sales organization, any sales organization to sell into those operating units.

So as we've improved those operations, now we can invest more on the front end of the business to make sure we drive through the increasingly efficient operations. Those are the things that we're doing really across all of our businesses. Remember one of the fundamental tenets we believe in, if we execute well, we think that's our best opportunity to get our customers to do business with us and they would tell you the same thing.

Great. Thanks a lot.

Jamie Sullivan, RBC Capital Markets

Hi. Good morning.

Good morning, Jamie

Question, so the bookings commentary, that was helpful, that makes sense. I'm still looking at the second half ramp in sales, you're looking at high single digits to get to the guidance range. But just wondering if you could give a little bit more color on the cadence you had, some of the change orders, your bookings this quarter, just wondering is it even heavier weighted towards 4Q than a typical year?

Again, I don't want to start parsing quarters. I've been going back to the original comment. Cadence in our backlog is driven as much by the customer right now as anything else. And the cadence in our bookings is going to be driven by markets and lead times that are required. So I can tell you right now -- as these things ramp-up, it is not a tight market. So that tends to shorten leadtimes on the products because time is money on these projects.

We go back to 2008 the market was tight and so leadtimes were extended, and I mean significantly, 30% to 40%. Something that would typically go out in mid-40s were going out in 72 weeks. So how this backlog rolls out is going to be as much driven by the customer as anything else; and in fact, that's what you've seen in the first half of this year. So as we look out over the horizon, as these projects start to mature and develop, that's going to drive it as much as anything else.

Jamie, it's Mike. The other thing I would just add, is just look at the increase in the backlog. Backlog is up $293 million since the end of the year, and then another metric to look at is backlog is up about $185 million year-over-year and that $185 million is composed of $56 million, that's in aftermarket, and certainly we would expect that to flow-through in the second half of the year. And then $129 million is up year-over-year in OE. And as Mark talked about, that's a combination of run rate items as well as some of the longer leadtime items.

So you would expect some of that $129 million to flow in the second half of the year as well. And so that will help you a little bit with the math as far as it gives us the confidence that we can hit the lower end of our guidance range.

Okay, thanks. And then just a follow-up on free cash flow, you've laid out the aspirational targets there for a little while, but just wondering what maybe should we expect in progress over the next 12 to 18 months given that you've had some of the customer dynamics in Latin America and OE starting to pick up?

I think we've really been working hard at that, and we've got a number of tools that we actually are rolling out as we speak. They went live actually this quarter and a number of new process and procedures and all that. So I'm optimistic we'll see that. Certainly some challenges with the Latin American environment, but I mean that's been a very good region for us for a long period of time. It's about 10% to 11% of our total revenues as a Company in that region. But I do expect that you'll see some progress over this next 12 to 18 months.

Okay. Thank you.

Joe Ritchie, Goldman Sachs

Hi. Good morning, everyone

Good morning

So my first question was really around the deferred shipments, can you quantify exactly how much was deferred from a growth and EPS perspective and whether you expect that to come through in the third quarter?

Joe, I'm having a little trouble hearing you on that. Can you state your question again? You might want to go a little slower, I think you're getting some feedback.

Sorry about that. Can you hear me better now?

I can.

The question was really around quantification of the large shipments that were delayed this quarter into 3Q. First, can you quantify the EPS and revenue impact as well as whether you expect that to come through in the third quarter?

We'll give you a high level. We saw probably about $50 million to $60 million of revenue growth role through on these projects from one quarter to the next. So keep in mind that can happen again in subsequent quarters as well, but that's generally what we saw relative to our original forecast.

Okay. That's helpful. And it clearly was a good order quarter for the Company. Middle East seems to be a big driver in the first half of the year, can you provide some commentary on the pricing and competitive dynamics that you're seeing in the region today?

I think I've made the comment before and it still applies, that is certainly a competitive area when you are bidding on projects. Now the aftermarket opportunities, you can get certainly good margin on that; but the Middle East is competitive, but it's important. We have significant investments there. We've seen good growth there. It does yield great aftermarket opportunities over the long term. But it certainly is remaining and we think will remain a competitive market. We've seen that. That's been in our backlog for a number of years, so what you're seeing now is still reflects the competitive environment in the Middle East.

Okay. But there's nothing -- you didn't sense any increased competition or the pricing dynamics intensifying in recent quarters?

No. It's been similar for quite a while.

Okay. Great, and one last question for you. On the aftermarket, you mentioned that you're taking the order book to a new level. Is $500 million plus the right new normal just given your focus on your end-user strategies, potential better penetration in IBD and FCD, or is some of this really driven by utilities and refineries that had deferred maintenance, then you're starting to see a pickup here over the last few quarters? I'm just trying to get a sense for underlying demand versus the opportunity for you to just increase your share?

I think the consistent cadence over the last four or five years has been an upstep in the trend from our end user strategies. You've certainly seen where running refineries flat out in North America, and we'll see a decline year-over-year in that, but the general underlying theme in our business as Tom talked about is we're driving aftermarket growth. That's been a consistent theme for four or five years.

Okay. Thanks for taking my questions.

You're welcome.

Kevin Maczka, BB&T Capital Markets

Thanks. Good morning

Good morning, Kevin.

EPD bookings, I'd like to ask a question there. That was much stronger than we expected in the quarter and I'm just trying to get a sense for your view of the momentum there because as we go back to last year, we had a nice run up there as well from Q1 into peaking in Q3 before it backed off. And so I know there's some lumpiness here, but I think there's also some momentum building in these markets. Want to just get your sense in terms of timing, was this kind of a stars aligned kind of a quarter or would you expect the momentum here to continue?

The EPD is two stories that are really very connected. The aftermarket growth you're going to see a lot of that in the EPD segment, so if you look at our valve segment historically that percentage has held consistent because a lot of what is in their OE is quick turn MRO, which is like aftermarket but you just replace a piece of equipment.

We've seen good growth in IPD but it's a smaller segment, so when you think about what drives EPD bookings, it's going to be our growth in the aftermarket business; and yes, to your point these projects. The opportunities that Tom talked about in these longer leadtime products fall in the EPD segment.

So I don't know it's as much as stars aligning. It can be lumpy and often times when we compare year-over-year as we will be next year, we maybe comparing to the project that we took in this quarter and that was in the EPD segment. It can be a little lumpy but what you should expect as these opportunities come on these projects that it is going to really benefit the EPD segment; and as we drive our end-user strategies, they will certainly get significant share of the aftermarket as well.

Okay and then in follow up there, in terms of pricing so you have the one notable project win in EPD, and I think you've said many times that you expect some of these early projects as the cycle builds to be very competitive but you want to stay disciplined on your pricing. I'm just wondering, can you talk about pressures you're feeling from your customers? I think there's been a lot of talk about customers pushing back and rebidding projects, and how do you just balance that dynamic between customers not wanting to pay more and maybe some of your competitors willing to be less disciplined than you?

Well, I'd still maintain as I look at our competitors they're all disciplined and they do things for their reasons. The way we look at those opportunities is if we can deliver on time to our customer at an appropriate cost, and I think the message here is we've got to look at efficiency within our facilities to drive more cost efficiencies to be competitive in the markets. I think where two competitors in our industry will have difficulty competing, one gains in the advantage over the other is if they can't deliver on the leadtime, if they don't have the technical capabilities, if they don't have the product offering, if they may not be able to support it over a period of time, and that will drive it.

Does that mean that on a certain bid one might think it's more beneficial than the other and drop their price in the competitive bid process? Sure, they can do that. They've always done that, but you are right, customers are demanding value; but if you can provide it, they're willing to pay for it.

Okay. Thank you.

Andrew Obin, Bank of America Merrill Lynch

Good morning

Good morning

I guess it's still morning. Just a question on M&A environment. I know you said you will allocate capital in a disciplined way, can you talk about the M&A environment and if you think there are even any targets available in North America? What are you seeing in Europe? What are you seeing in Asia, just a broad overview because I wonder if anything can be done at all over the next 12 months?

Well I think we've been talking about this environment for a while, and we've been able to successfully bring in some bolt-ons over the last couple of years. There are assets out there. Some of the larger ones everybody sees, and they're going to be fairly competitive in terms of people acquiring them.

From our standpoint we really need to look at what we've talked about before. Can we drive the efficiency and deliver value to our shareholder by loading it on our platform? One of the advantages we have is we've got a very broad platform, sales platform, and aftermarket platform, which allows us to realize what I would say are the topline in margin synergies in the business and then you can get down to the cost take-out. But I know a lot of the market right now is around SG&A cost take-out or what's driving M&A transactions. We'll stay to really the strategic value first, and being able to drive topline growth and leverage it.

Now taking a step back in the environment right now, there are assets out there, there are assets that are coming out there, a lot of people certainly have their eyes on them, and we'll just have to be disciplined in the way we approach it. As we talked about on our Analyst Day, over the next couple of years, our cash generation is going to support our ability to take advantage of it and were going to stay disciplined. It's opportunistic.

Talk to any company out there and it's one of the things they probably have the least control over is when an asset becomes available and is it going to be at the price they want it. So we'll keep an eye towards that; but at the same time, what we want to do is make sure we're focused on our organic opportunities and improving our business platform. Because to my comment earlier, we've got plenty of room for improvement here.

Let me ask you a follow-up question, your execution on relatively weak topline has been pretty good. How do you balance margins versus execution when volume starts to accelerate, and what are you guys doing internally to make sure that you can execute on higher volumes without negative margin impact.

That's a great question and I think that it probably has a 45 minute answer, but I'll try to summarize it for you. Our lead product, secondary product strategies to where we actually create more capacity in a product line globally, not only does it drive efficiency, cost efficiency, and the ability to deal with higher volumes; but it really positions us to be able to take care of customers all around the world and be responsive especially where there's local content that's required.

I think the other thing is just some of our focused initiatives around some of our facilities to get them improving and get better output. As I made in my comments earlier, in all of our segments particularly in EPD we have the room for improvement in some of our facilities, to bring them to a better level of efficiency and efficiency doesn't necessarily mean cost reduction. Oftentimes it means better throughput and really reducing the underabsorption in the facility.

So those are the things that we work on. The discipline around how we take an order in and make sure it's clean helps us to drive shorter lead times and more efficiency. Those are three examples of things that we're working on; but at the end of the day, it comes back to execution and being responsive to the customers and disciplined in how you take these things. What we don't want to do a set ourselves up in the bidding process and disappoint our customer.

And as Mark mentioned, one of the basis is for dealing with increased activity is to have a good base to begin with and that's what we spent a lot of time on over the last several years is getting an on-time delivery correct, getting the quality right, setting up the low-cost sourcing base, and making sure that the businesses can take the load and execute on the base. Then that gives you that opportunity to increase when that volume does start to come through the business.

Terrific.

Nathan Jones, Stifel

Good morning, everyone

Good morning, Nathan

Mark, I think this is probably the most bullish I've heard you on the project cycle since the last recession. We're always looking at this not being a quarter to quarter business, and I think there's definitely a big change in tone from the last quarter to this quarter. Can you just elaborate a little bit more on were that confidence comes from and what you see out there in the market that's giving you the confidence to be a little bit more open about the way you're feeling about the cycle?

Well one thing I'll emphasize where the tone has been consistent is my optimism around the opportunities here in terms of improving the business and our run rate in aftermarket; but to your point, it is good to see some of these longer lead time products come in. Because we've been having this discussion now for four or five quarters that opportunities on the horizon, and we've all been patiently and maybe some folks impatiently waiting for these things to come in. I think that's what gives us some encouragement but I definitely want to make sure I'm balanced in saying that a lot of the opportunities are still in front of us.

I think you've heard that generally from the market. We were pleased to see some of these longer lead time products come in during this period of time. And I think what's giving me the most optimism, or what I'm very encouraged about, or what was in my comment, margin improvement and the progress I'm seeing in this business gives us the platform to really be able to drive growth in this business and remain competitive. That's what's been more encouraging. Simply put it's good when a plan comes together, and we embarked on this a little less than three years ago, and I think you're hearing more than anything I'm just pleased with the progress.

That's what's driving my optimism more than anything else. The market's will be what the market's will be. We know what the secular drivers are in the industry are around the world. I know we've got work to do, I'm also encouraged by that.

As we sit here right now I know we still have 2 to 2.5 years more work to be able to improve our platform. So from management's perspective, when you have things to work on and your plans are starting to come together and you see your core base business of aftermarket and original equipment starting to growing and continuing to grow and now you see some project opportunities come in, you're encouraged. But you're always balanced in how you still have work to do.

Margin improvement has obviously been excellent. Assuming that this cycle is as strong as most people think it will be, where are you in terms of capacity, just in terms of manufacturing capacity, and then project management and all the other things that you need to deal with a big upcycle?

That's a good question. In the project management, we're still in the early to mid stages in terms of bringing that discipline to the level where we need it to be; and we're working very quick, we made a lot of investments in that area. On the capacity side, we have ample capacity. If you think about what we've added around the world in Brazil and not only was it more square footage but it is state-of-the-art and throughput and efficiency is significantly higher than the other facility that we had.

We've added in China. We've added our third block in India and then just our LPOSPO strategy, which brings up a lot of additional capacity, we're comfortable with the capacity we have going into this environment. Especially as we see right now, it's more of an orderly cycle than we saw in the last time. That's good for our industry.

So as we look at those two aspects of our capacity, plenty of square footage, not concerned about that. Some of the resources and capabilities, we need to continue to invest in but we're on it. And then just improving the operations. That's one of the best things we can do to create in effect capacity out of the square footage that already exists.

All right. That's very helpful. Thanks very much.

Jim Giannakouros, Oppenheimer & Co.

Hi. Thank you. Good morning. If I can tack on to that last question as far as your aftermarket step up to the new run rate that you referenced above $500 million, how does that stand relative to your QRC capacity? Is that driving the need to expand it or capabilities above the aforementioned QRC facility construction that you anticipate as the large OE project wins come down the line?

The QRCs are one medium, one avenue, one pool we use to deliver our aftermarket capabilities. So we've talked about this before, it's not like a retail model where you have in a sense same-store sales, and if you add more facilities that in and of itself will drive your aftermarket. There has to be a need for that QRC there. Oftentimes we're delivering aftermarket capabilities on site in the facility without a need for specific QRC. But having said that, we have the opportunity to deploy more QRCs around the world, that will continue to support our growth. We just need to make sure there's the market there and the customer is ready for it on the QRC side and really that local presence.

Understood. And one follow up if I may. The gross margin progression year-over-year improvement particularly in EPD but across-the-board really, can you at least rank order if not quantify the drivers that you've called out such as mix and improving backlog quality and execution on the plant floor, et cetera?

Probably on a comparative basis, if you're looking year-over-year, one of the primary drivers was the discipline we put in place two years ago. Somewhat of a contributor has been the operational improvement that we're about halfway through. To a lesser extent but that will abate as we look at continuous improvement in our facilities and actually as volumes increase absorption that hasn't really been as much of a factor, but if you rank order the three that's how I would rank order them.

By the way there's other things like mix and product offering and things like that that play a factor in it, but at a high-level in terms of what I'd call the operational excellence, things that we're working on here. Those three, that's how I would rank order them. So the opportunities are improving the business and then improving absorption in our factories through continuous improvement, evaluating the capacity that we need, but also just volumes as well.

Great thank you.

At this time I see we have no further questions.

If we have no further questions at that point, we will say that we appreciate everybody's participation in today's call, and we look forward to seeing many of you at upcoming investor events. Call Mike Mullen or myself if you have additional questions and this will conclude today's call.

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