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Flowserve Corp. (NYSE:FLS)

Q2 2009 Earnings Call

July 30, 2009 11:00 am ET

Executives

Paul Fehlman - IR

Lew Kling - Chief Executive Officer

Mark Blinn - Chief Financial Officer

Analysts

Kevin Maczka - BB&T Capital

Hamzah Mazari - Credit Suisse

Scott Graham - Ladenburg Thalmann

Karen Finerman - Metropolitan Capital

Jamie Sullivan - RBC Capital Management

Mike Schneider - Robert W. Baird

Charlie Brady - BMO Capital Markets

William Bremer - Maxim Group

Operator

At this time, I would like to welcome everyone to the Flowserve second quarter 2009 Earnings Call. (Operator Instructions).

I would now like to turn the conference over to Mr. Paul Fehlman, Vice President of Investor Relations. Please go ahead, sir.

Paul Fehlman

Welcome to Flowserve’s second quarter 2009 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.

Before we get started with the presentation, I’d like to point out a few important items. Firstly, for those of you that have accessed today’s call through our dial-in phone number and also wish to follow along with the earnings presentation slides via our website, please click on the click here to listen via phone icon at the bottom of the Event Details page.

I’d also like to note that our webcast will be posted on our website for replay approximately two hours following the end of this call. The replay will stay on the site for on-demand review over the next few months.

Joining us today are Lew Kling, President and CEO of Flowserve; Mark Blinn, Senior Vice President, Chief Financial Officer and Latin American Operations; and Dick Guiltinan, our Chief Accounting Officer. Following our commentary, we’ll begin the Q&A session.

Regarding any forward-looking statements, I’ll refer you to yesterday’s earnings release and 10-Q filing and today’s earnings presentation slide deck for Flowserve’s Safe Harbor statement on this topic. All of this information can be found on Flowserve’s website under the Investor Relations section. I encourage you to read those statements carefully with respect to our conference call this morning. The information in this call, including all statements by management, plus their answers to questions related in any way to projections or other forward-looking statements, are subject to Flowserve’s Safe Harbor.

Now, I’d like to turn it over to Lew to begin the formal presentation. Lew?

Lew Kling

Thanks, Paul, and good morning. It’s a pleasure to welcome you to our 2009 second quarter earnings conference call. I am pleased to report another strong quarter for Flowserve, highlighted by sequential quarter-over-quarter in bookings, most notably driven by the Pump Division, taking us back to the $1 billion quarterly mark again, followed by strong sales growing almost 4% over last year on a constant dollar basis, and once again the continuation of improved gross and operating margins when we exclude the impact of our realignment expenses.

During the next few slides, I plan to discuss many of the key company highlights from the second quarter, as well as many of the primary performance metrics that we’ve achieved during the period. As I’ve done several times on these calls, I’ll discuss what we are currently seeing in our major markets, oil, gas, power, water and chemical. Covering not only the current macro environment, but also the areas of particular strength and weaknesses inside those markets, as well as the continuing long-term drivers of demand.

Although some of the uncertainty in the global marketplace that surfaced from last year has not gone away, we remain cautiously optimistic that many of our key end markets are beginning to show some signs of stabilization. As you may recall from our first quarter earnings presentation, I stated that we saw relatively stronger pump bookings performance during the latter part of the first quarter that continued into the early part of the second quarter. I am now pleased to report that our pump bookings performance in the second quarter did indeed strengthen by 15.3% versus the first quarter. On a quarter-over-quarter basis, pumps produced a currency adjusted bookings number just 2% lower than the same quarter a year ago, which was the third highest pump quarter in the history of the company. When you additionally consider the impact of the thruster orders in 2008, pump bookings were essentially flat year-over-year.

Inside the Pump Division, this quarter was a story of successful end user strategies, operational excellence, global reach, product breadth, customer relationships, and a focus on gaining market share. Because of our integrated global project tracking system and strong sales leadership, we are able to bring the full extent of our global resources to bear on targeted bookings opportunities, while still driving acceptable margins.

Across all our divisions, we believe that our strategy of continuing to provide superior products and services, industry leading on-time delivery, strong customer support, multifaceted customer partnerships, while expanding our presence in new, growing market sectors, and more importantly now security of a solid balance sheet, has allowed us to continue to drive superior shareholder value.

We have also implemented most of our earlier announced realignment plans for the year and have recognized about three-quarters of our full year projected expenditures, using our strong cash position to reduce or optimize certain non-strategic manufacturing facilities, as well as more aggressively driving further initiatives that are designed to better support lowering our overall cost structure and strengthening our operating platform going forward.

While we have projected 2009 realignment charges of up to $40 million during the year, we have achieved around $7 million in cost structure savings from the realignment so far this year and believe we can achieve $22 million in savings during the latter part of 2009, with full benefits expected in 2010 and beyond. We are also reinvesting some of these benefits in our strategic markets and other opportunities supporting future growth.

Slide three provides an overview of the most notable highlights achieved during the second quarter of 2009. This quarter was a different environment than we experienced in the second quarter last year. Back in 2008, commodity prices were booming. Oil reached $140 a barrel and the US dollar was considerably weaker with the euro reaching almost $1.60. Today, oil is about half of what it was and the dollar is stronger. But even in these conditions, we believe there are still opportunities in our markets.

Despite the financial, economic and capital market challenges, I am pleased to report that this year’s second quarter was another terrific earnings quarter for Flowserve, driven by excellent operating results, execution on continued cost reduction and strong top line performance. We posted earnings per share of $1.92, which included $19.6 million, or $0.25 per share, of realignment charges. Looking at this another way, excluding realignment charges, Flowserve earned $2.17 for the second quarter, despite the worldwide macroeconomic situation.

Our bookings performance for the second quarter represented a decline of 21% versus the prior year, or a 12.9% decline when we pull out the 8.1% of negative currency impact. I would also like to note that this comparison is against the highest second quarter bookings performance in the history of Flowserve, $1.3 billion, which was up approximately 24% over the second quarter of 2007 and also included about $22 million of our thruster products.

Most importantly, our second quarter bookings were up approximately 7% sequentially versus the first quarter of 2009, an indicator of possible stabilization of some of our end markets and the positive impact of our strategic initiatives towards gaining market share. As we have continued to point out, even in declining markets, global capital spending does not go to zero, since oil, gas, power, water and chemicals, are still needed across the globe.

We will discuss the individual results by our three divisions later in the call, but it bears noting that the strong bookings performance turned in by our Pump Division is usually a favorable OEM market indicator, since pump orders tend to sequentially lead valve and seal orders related to large projects, because they’re generally purchased earlier due to their longer manufacturing lead times.

In addition, our bidding opportunities have remained active, our current pipeline of large project opportunities is still good, and our aftermarket opportunities remain strong. Although we have continued to experience some delays in the customer order placement process that began during the fourth quarter last year, we have still not seen a significant level of cancellations in our backlog. We are also pleased that our book-to-bill ratio at the end of the second quarter was 0.95, meaning we continue to maintain strong backlog levels.

Sales were $1.09 billion, or 5.8%, compared to the second quarter of last year. But on a constant currency basis, they were actually up 3.7% over last year, demonstrating the resilience of our backlog and our strong aftermarket performance. I am also particularly proud to report that we continue to improve our operating margin, reporting a 14.6% margin, or a record 16.4%, excluding the second quarter realignment charges of $19.6 million. As you can see, we have not relaxed our constant focus on cost and operational efficiency and have made significant improvements this quarter in both our gross margin and SG&A expenses. As I have discussed before, we believe there are still opportunities for improvements in our operating platform through operational excellence and cost initiatives.

And finally, our cash flow from operations was very strong in the second quarter, up $108 million compared to last year at this time, driven primarily by improved working capital. As you will see later in the presentation, our advanced cash balance also remains strong, confirming the confidence our customers have continued to place in Flowserve.

Slide four lists the financial highlights for the first half of the year and serves to underscore the solid earnings, sales and margin performance that Flowserve has achieved so far in 2009. I wouldn’t be doing the Flowserve team justice if I didn’t point out that our year-to-date reported earnings-per-share was $3.56, down only 2.5% from last year, and it contains $0.38 of realignment charges that we did not incur last year.

In addition, our year-to-date operating margin of 14.5% was up 90 basis points in the same period last year. Excluding 140 basis points of realignment expense year-to-date, operating margin was 15.9%, up 230 basis points from last year.

Due to the strong performance afforded by our significant backlog, improved operating platform, execution on realignment initiatives and a weaker dollar, we are raising our previously stated 2009 earnings per share target range of $6.75 to $7.50 per share to a new target range of $7.15 to $7.75 per share, which also includes the full impact of up to $0.50 per share in realignment costs.

As you can see on slide five, the reported 2009 second quarter bookings were down from the second quarter of 2008, primarily in chemical and general industries. Power, oil and gas, and water remain resilient, underscoring the relative strength of demand in those markets, supported by our strategic market share capture initiatives. Together they helped drive us to surpass the $1 billion mark for the quarter once again. As evidenced in the graphs on the bottom half of the page, our reported aftermarket business fell less than 5% year-over-year, but was actually up almost 4% excluding the negative currency effects. A testament to the value of our end-user strategy and its execution.

Relative to the bookings reduction in general industries, I should note that this category contains business which passes through our distributive channels. For the past couple of quarters, we have seen a slowdown in order rates from our distributors, as they move to lower their inventory levels in light of the current economic challenges. We believe as the economy recovers and the customer spending increases, distributors will need to quickly restock their inventories, which will provide business opportunities to companies that can rapidly ship products anywhere in the world on time, which falls right into our sweet spot.

Slide six breaks down our sales for the second quarter by region and by mix. As you can see, there were minor shifts in sales away from North America and Asia, and towards Europe, Middle East and Africa.

Slide seven covers the key financial metrics in a traditional P&L format for the second quarter. The chart clearly points out one of the recurring themes in our discussions during 2009 compared to 2008, that being the effects of currency headwinds in the first half of the year and the strength of our top line in the second quarter and year-to-date.

On a constant dollar basis, second quarter bookings were down only 12.9% instead of the reported 21%, and sales were actually up 3.7% instead of the reported negative 5.8%. The year-to-date results also on a constant dollar basis, show bookings down only 18.8%, instead of the reported 27%, and sales up 9% from the record levels of 2008, instead of the reported negative 1.7%. Finally, our adjusted operating income, operating margins and EPS offer a more clear line of sight to our continued margin improvement and EPS growth year-over-year when the impact of realignment charges and prior year tax benefits are considered.

For the second quarter, adjusted earnings per share becomes $2.17, up 2.4% over the same quarter last year. Year-to-date adjusted earnings per share becomes $3.94, up 7.9% over the same period last year.

Slide eight, our familiar bookings chart demonstrates the quarterly progression of bookings performance over the past five years. As I mentioned earlier, our bidding opportunities have remained active, our current pipeline of large projects is good and our aftermarket strategies continue to drive new opportunities. Furthermore, as I’ve also said earlier, the strength of project bookings for the Pump Division is usually a helpful indicator for the potential future strength of bookings to come in the valve and seal divisions, which typically lag the longer manufacturing pump cycle orders.

Again, as we normalize bookings for currency headwinds and exclude the thruster bookings in the second quarter of last year, we were down only 11.6% versus the second quarter of 2008. I’d also like to point out again that we have not seen a significant level of cancellations in our backlog, and our terms and conditions in our contracts and the advanced cash from our customers should also provide us with a buffer to protect us from significant negative financial impact if cancellations were to occur.

Slide nine shows the quarterly progression of our strong sales growth over the past five years. Just as a reminder, as the as-reported sales in the second quarter of 2009 show a 5.8% drop versus the second quarter of 2008. But it would have been 3.7% in constant dollar terms without the 9.5% currency headwind.

I am certainly pleased that our operations have been able to achieve this higher level of constant dollar shipments, while simultaneously completing the realignment actions to date designed to improve future efficiency of our operating platform. This demonstrated ability to achieve short-term shipping targets, while handling long-term realignment objectives, in my opinion bodes well for our future.

I would now like to shift gears for a couple of minutes and discuss our view of the current markets. Slide 11 covers what we’ve been discussing on several previous occasions, that being the persistent drivers of global infrastructure investments. From our perspective, these drivers remain constant regardless of economic conditions, and are the basis of why infrastructure spending continues even in recessionary periods. There is no doubt that the overall size of the capital investment has been impacted by the current economic conditions. However, staying focused on our customers and their needs has provided Flowserve with opportunities, as demonstrated in this quarter’s results. We believe that understanding the fundamentals of these market drivers and the needs of our customers provide us with a continuing opportunity to expand market share in our target industries and geographical markets.

Slide 12 covers one of the key growth industries, power. This industry has experienced continued growth in investment, driven by the persistent growth in demand for electricity and the unavoidable need to refurbish and upgrade aging infrastructure. The challenges facing this industry are driven more by social and environmental concerns, than by the current economic recession. These concerns are accelerating the pace of initiatives around reducing greenhouse gases and advancing the use of renewable energy sources.

The global legislation efforts to reduce carbon emissions demonstrate the increased focus on the environment, leading to a future where cap-and-trade policies will most likely become a major driver of investment. This focus will have an impact on the types of power generation employed in most existing and future power generation facilities that drive for increased efficiency, creating opportunities for Flowserve in both renewables and carbon emission management systems.

Over the past several years, we’ve been anticipating these changes and developing solutions, which I’ll discuss on the next slide. As you can see on the right side of this chart, a significant level of opportunity exists within the power industry with a forecast of more than 500 gigawatts of incremental capacity planned over the next five years. To bring us close to the home, 500 gigawatts of power is 1,500 megawatt power plants. Most of this expansion will occur in the developing regions of the world where Flowserve has invested over in the past five years to establish and/or expand our local presence. The investment temperament of this industry has been demonstrated in the recent announcement showing planned investment for power infrastructure of over $400 billion.

These plans include such items as $88 billion in China for nuclear expansion, $28 billion in investment by Saudi Electric to meet expanding demand, and the need for U.S. utilities to spend approximately $250 billion over the next three years due to aging infrastructure, increased regulation, and projected demand. We are also experiencing strong proposal activity within the power industry, including projects for retrofit and upgrade of existing power plants, which fits well within our newly created Integrated Solutions Group.

Overall, the outlook for forecasted spending, in the areas of new power generation, upgrades and existing operations, and plant-wide maintenance, remains favorable despite the current economic challenges.

Slide 13 provides a high level overview of areas which will be affected by the cap-and-trade legislation currently under consideration around the globe. These areas include clean coal, nuclear, carbon capture and storage, and renewable energy such as solar, geothermal and wind. Clean coal technologies, such as supercritical and ultrasupercritical, are designed to provide more efficient operations by utilizing higher temperatures and pressures, which leads to reduced carbon emissions, while maintaining the same level of generating capacity as conventional coal-fired methods. We’ve been working with our customers over the past several years to develop and now produce products capable of withstanding these more critical conditions of temperature and pressure, and we stand ready to meet their requirements today.

In the area of nuclear power, the reactor designers have developed third-generation designs capable of producing higher levels of output with greater efficiencies. Flowserve is actively engaged with many of these designers, working to ensure that our product offerings remain compliant with requirements of these new designs. By leveraging our long-standing presence in the nuclear market and maintaining our "N" Stamp certification capabilities, I believe we are well positioned to grow market share in this segment of the power industry.

In fact, I am pleased to report that, last night we were awarded a new nuclear valve order for greater than $45 million for four new Westinghouse nuclear power units to be built in the southeastern part of the United States. These four units represent the first new nuclear power projects in the United States since 1977.

Carbon capture and storage is a subject we have all been hearing and reading about in the news lately, especially with the environmental legislation currently under consideration. This is a technology which is still in the development stage, and many of the participating organizations are earmarked for funding from government plan stimulus programs. Since many of the techniques under consideration will transform the carbon dioxide into a liquid state, as well as utilize other liquids in the process, the need for Flowserve’s portfolio of pumps, valves and seals provides future business opportunities. In fact, Flowserve is actively working with customers in this area, both on pilot programs already underway or on projects in their early stages of development. We view carbon capture and storage, as well as other developments related to the reduced carbon footprint as additional market opportunities for future growth.

As for the renewable sources of energy, we have discussed these on several previous occasions. In the areas of solar, geothermal and wind, we are working with our customers to provide the technology for products and services they require. Based on our continued focus on being close to our customers and driving investment in new product capabilities and flow management solutions, we feel we are well positioned to serve the needs of these developing application markets.

Slide 14 takes a look at the current challenges and opportunities in the oil and gas markets. The challenges are pretty clear and are driven by current global economic recession. Demand forecasts for oil and its related products has been reduced from previous levels with overall demand projected to return to 2008 levels in 2011, and then continue growing into the future. This projected drop in demand for 2009 and 2010 is driven primarily by the reduction of oil requirements in the transportation and industrial markets.

In the gas industry, the significant new finds over the past few years have now created a potential overcapacity condition resulting from the current drop in demand for natural gas relating to the economic recession. This projected drop in demand for natural gas is forecasted to last only through the current year, with demand returning to 2008 levels in 2010, followed by overall demand growth in the next several years.

Looking further into the oil market details, overall demand for oil is now forecasted to decline in the mature markets from 2009 to 2013 and grow in the developing markets over the same period. This dynamic supports the current project activity and plans which are largely in Asia, the Middle East, India and Latin America. Despite the current economic concerns, several of the large projects placed on hold early this year are now breaking loose for rebidding and contracts are being awarded, as you have seen through announcements in the recent press.

This major project activity is being driven by the previously discussed drivers of global infrastructure investment, construction costs dropping in line with current expectations, as well as the eventual need to increase supply capacities as demand returns to a growth mode. These investments include upstream, midstream and downstream projects, which also include continuing investments in liquefied natural gas projects globally. Based on our market position and our ability to meet the needs of these market applications, we believe we are well positioned to continue to grow our market share in the oil and gas industries.

Slide 15 represents a similar view for the water industry, looking at challenges and opportunities with a focus on the desalinization market. The water industry faces two primary challenges, the first and most prevalent being the availability of fresh water, and the second being the availability of funding for these projects.

The funding issue is one resulting from the current economic recession, which is causing a reduction in available tax revenues needed to finance water projects. Portions of the government stimulus funds are being earmarked for water development. However, much of the work required in local areas depend on local tax dollars for funding. The challenge relative to the lack of accessibility to fresh potable water continues to drive investigation into methods to produce and transport fresh water from source locations to areas where it’s needed. Desalination may become one of the primary sources of potable water to many of the water-stressed regions around the world.

As mentioned in previous presentations, the estimated spend on capital investments for desalination through 2016 is projected to exceed $64 billion. Recent project information from global water intelligence showed an estimated 330 reverse osmosis projects either planned or under construction, providing in excess of 18.5 million cubic meters per day of capacity expansion. It is worth noting that long-term projections of water demand show an increase in desalinization exceeding 100 million cubic meters per day through 2025, with some forecasts even higher.

The reverse osmosis market is projected to provide a market opportunity for flow management and energy recovery in excess of $6 billion over the next five years. As we continue to integrate the recent CALDER acquisition, we have improved their competitive position in the desalinization market, providing a stronger platform from which to build market share in this important industry. We believe that the combination of the energy recovery technology of CALDER and the flow management capabilities of Flowserve provide a strong integrated product and solutions portfolio to meet the needs of this growing market. Our recent project wins give us confidence that our solutions are in line with customer requirements for current and future applications.

Slide 16 provides a view of challenges and opportunities within the global chemical industry. This industry is undoubtedly the hardest hit of the infrastructure industry by the current economic recession. With global GDP and customer spending projected to be soft over the next couple of years, the industry is experiencing significant drops in demand for basic and specialty chemicals. The mature regions of the world are feeling the effects of the market decline more severely than the developing regions of the world.

Plant closures and headcount reductions are occurring across most parts of the mature markets, with the remaining operational sites running an average below 75% in capacity utilization. The current market conditions appear to be driving consideration around consolidation within the industry and a move by the major companies to focus more on specialty chemicals to maintain a value supplier position.

Opportunities, although fewer, still exist, particularly in the developing regions of the world where majors, as well as local companies, are investing in lower cost operations for basic chemical productions. As you can see in the charts in the upper right, over 94% of all planned capacity additions are targeted for the developing regions, with particular focus in China, India and the Middle East.

Opportunities are also developed due to the aggressive destocking behavior from the first part of the year. Many companies have now reached marginal inventory levels requiring increased production to replenish their inventory. This should also provide aftermarket service opportunities, as facilities begin using equipment which has either been shut down for a period of time or operated at less than optimal levels. Therefore, despite the challenges faced in the chemical industry from the global economic recession, business opportunities still exist to expand and grow market share globally.

Slide 17 covers our view of the aftermarket business. As I have discussed in previous presentations, we believe that the aftermarket is supported by persistent need for fuel, electricity and water, and therefore should provide a sustainable business growth opportunity. In evaluating our performance for driving growth, we need to look at our revenues from both a reported and constant dollar perspective.

As you can see on the slide, our aftermarket revenues have grown year-over-year from 2005 through 2008. In the first six months of 2009, we did see a reported revenue decline of 6.4% compared to the same period last year, but this was impacted by currency headwinds, which have neutralized what would’ve resulted in revenue growth of approximately 3%. In order to measure true base growth of our aftermarket revenues, we need to analyze the data in a constant dollar format, thereby eliminating the fluctuations caused by currency.

The second chart on the right shows the revenues over the same period now referenced to a 2009 constant dollar. This chart demonstrates that we are truly growing our aftermarket base year-over-year, as well as period-to-period, providing confidence that our growth strategy is creating desired financial results.

Returning to the reported revenues, I am pleased with our aftermarket revenue performance in the first six months of the year, considering the fact we had a significant slowdown of spending during the first two months of the year, as our customers tried to figure out the impact of the recessionary economy on their business. In addition, considering that the second half of the year is typically stronger than the first half, as seen in the graph, and overall the past several years we’ve significantly increased our installed base that’s just now beginning to come out of warranty. I believe that our aftermarket business will remain a major component of our growth opportunities.

Slide 18 shows where we believe we can create differentiation from our competition. These are also the drivers which provide us the strength and capabilities to grow our market share even in recessionary markets. Our entire management team remains totally focused on staying close to our customers, exceeding our customers’ expectations, providing advanced technology solutions, globalizing as required by our customers and maintaining one of the strongest balance sheets in the industry. I truly believe that by excelling in these critical areas, we can maximize our financial performance while driving market share growth despite global economic challenges.

In summary, I am really proud of what our company has accomplished in the first six months of the year, as well as our employees’ ongoing commitment to excellence and serving our customers. I look forward to the future.

Now I’d like to turn the discussions over to Mark for a closer look at the financials.

Mark Blinn

As Lew discussed, we are very pleased with our results for the quarter, which demonstrate the strength of our global platform and aftermarket capabilities. Looking at bookings, second quarter bookings reported were down 21%, or 11.6% if you exclude currency in the thruster orders. First half bookings down 27%, were down 16.3% excluding currency in thruster orders. Sequential bookings were up Q2 versus Q1 and resulting in a 0.95 book-to-bill and a strong backlog of $2.71 billion.

We also saw continued aftermarket opportunities. Second quarter aftermarket bookings were down 4.7%, but up 4% excluding currency, and first half bookings were up 2.6% when you exclude currency. We saw good sequential growth in aftermarket bookings of 9.6%, or 6.3% excluding currency. As expected, we saw a shift in aftermarket orders, 700 basis point shift in Q2 and a 900 basis point shift year-to-date.

Our second quarter results also highlighted the continuous improvement of our operating platform. Second quarter reported margin was down 30 basis points to 14.6%, but up 150 basis points to 16.4% excluding realignment. We saw continued SG&A reduction as a percent of sales, down 40 basis points to 21.2%, or 110 basis points to 20.5% excluding realignment.

As to our realignment initiatives, we also saw benefits in the second quarter. The chart on the bottom of slide 21 shows that in the first half we’ve seen $7 million of benefits with over $6 million occurring in the second quarter. We expect $22 million of benefits in the second half of the year and $10 million of costs for a net benefit of $12 million. More important, what we see is a $56 million annual run rate in our business going forward.

As we have mentioned, it’s important to note that we have been and will continue to reinvest some of these benefits in strategic opportunities around aftermarket, India, China and the Middle East.

Slide 22 shows the result of our operational excellence, cost and realignment initiatives over the last four years and how it has substantially improved our operating platform. If you look at the metrics around SG&A as a percent of sales, corporate expense and operating margin, you can see good, systemic improvement. Looking down at our manufacturing footprint, as we said before, we have strategically optimized our manufacturing footprint over this period of time.

Finally, we are also very pleased with our second quarter cash flow of $102 million. We grew our cash balance by $50 million, and during the quarter we made a $25 million contribution to our pension plan and spent $28 million in the acquisition of CALDER.

Turning briefly on slide 24 to our consolidated financial results, sales of $1.09 billion were down 5.8% reported, but up 3.7% on a constant currency basis. Gross margin reported was down 70 basis points to 35.4%,, but that did include 110 basis points of realignment impact. SG&A improved 40 basis points to 21.2%, but that also included 70 basis points of realignment expense. The result was that reported margins were down 30 basis points to 14.6%, but adjusted margins increased 150 basis points to 16.4%.

Our reported earnings were $1.92. Adjusted earnings of $2.17 represented a $0.05 increase over the prior year. If you remember, in the second quarter of last year we had discreet tax benefits of $0.16.

Looking at the year-to-date results, sales of $2.115 billion represented a 1.7% decrease reported, but an increase of 9% on a constant currency basis. Gross margin year-to-date improved 20 basis points to 35.7% and included 90 basis points of realignment impact. SG&A improved 80 basis points to 21.6% and also included 80 basis points of realignment costs. The result is that reported operating margins improved 90 basis points over the year to 14.5% and adjusted operating margin improved an impressive 230 basis points to 15.9%. Year-to-date reported earnings were $3.56. Adjusted earnings are $3.94, representing a $0.29 increase over the prior year.

Turning to the Pump Division results on slide 25, the Pump Division delivered impressive bookings, sales and operating margins during the quarter, as it continued to leverage its global presence and aftermarket capabilities. Bookings were $650 million, down 11.7%, or 2.2% on a constant currency basis. When you consider the impact of the thrusters, their year-over-year orders were actually up 1%. Sales of $660 million were up 4.2% and up 15.1% on a constant currency basis. The Pump Division book-to-bill was 0.99.

Looking at their gross margin, gross margin did decline 40 basis points to 32.1%, but that includes 110 basis points of realignment costs. SG&A improved 140 basis points to 15%, and that also includes an impact of 30 basis points of realignment cost. The result is reported operating margins improved 80 basis points to 17.2% and adjusted margins improved an impressive 230 basis points to 18.7%.

Looking at the year-to-date results. Year-to-date bookings of $1.196 billion represent a 26.5% reported decreased, and on a constant currency basis, a decline of 17.5%. If you exclude the thrusters, the decline was 13.3%. Sales, $1.259 billion, an increase year-over-year of 5.5%, or 17.3% on a constant currency basis. Gross margin improved 70 basis points to 32.6%, and that included 85 basis points of realignment charges.

SG&A improved 130 basis points to 15.5%, and that includes 20 basis points of realignment charges. The reported operating margins increased 200 basis points to 17.3% and year-to-date operating margins on an adjusted basis increased 300 basis points to 18.3%. A strong market position, coupled with great execution, resulted in high margins for the quarters and year-to-date.

Looking briefly at the pump original equipment and aftermarket mix, you can see that in the quarter reported aftermarket bookings were down $8 million, or 4%, but up 7% on a constant currency basis. Year-to-date the aftermarket orders reported were down $38 million, or 8%, but up 2% on a constant currency basis. This $38 million decline does include $17 million of commissioning spares from 2008.

Looking at the Valve division on slide 27, the Valve division saw the impact of the year-over-year decline in the chemical and general industries, as well as the impact of destocking by distributors, and yet they continue to execute on operational excellence and cost initiatives, which drove improved margins.

Bookings of $273.9 million were down 36.2%, or 30.4% on a constant currency basis. Sales of $302 million were down 18.3%, or 10.5% on a constant currency basis. Gross margins improved 10 basis points to 36% and included 110 basis points of realignment costs. SG&A increased 150 basis points as a percent of sales to 20.8% and included 120 basis points of realignment charges. Reported margins were down 150 basis points to 15.5%, but adjusted operating margins improved 80 basis points to 17.8%.

For the year-to-date, bookings of $575.9 million represented a reported decline of 29.7%, or 22.8% on a constant currency basis. Sales of $599.6 million represented a 10.6% reported decline, or 1.2% decline on a constant currency basis. Margins for the year improved 40 basis points to 36.1% and included 60 basis points of realignment. SG&A increased 20 basis points as a percent of sales to 20.9%, and included 70 basis points of realignment. Reported margins were down 10 basis points to 15.7%, but adjusted margins were up 120 basis points to 17%, a solid performance.

They’ve continued to focus on operational excellence and costs. While they have seen the impact of the chemical sectors and the impact of destocking by distributors, they are well positioned in growth areas, such as nuclear, as evidenced by the $45 million plus Westinghouse nuclear order announced today.

Looking at the Seal division results on slide 28, the Seal division saw a decline in project orders and overall decline in orders from the chemical industry, yet they continue to focus on their QRC networking cost structure and drive aftermarket growth. Bookings of $131.6 million represented a 22.4% decline, or 16.5% on a constant currency basis. Sales of $144.7 million represented a 16.8% decline, or a 9.9% decline on a constant currency basis.

Margins in the quarter improved 70 basis points to 46.4%, including 90 basis points of realignment. SG&A increased 290 basis points to 27.8%, including 100 basis points of realignment. The result was that reported operating margins decreased 210 basis points to 19.7%, but adjusted operating margins decreased only 20 basis points to a strong 21.6%.

For the year, bookings of $264.7 million represented a decline of 22.3%, or a decline of 15.6% on a constant currency basis. Sales of $288.4 million represented an 11.2% decline, or a 3.1% decline on a constant currency basis. Gross margins were flat year-to-date at 44.9% and included 150 basis points of realignment costs.

SG&A for the year has increased 280 basis points to 28.8%, but also included 140 basis points of realignment. The result is that reported operating margins were down 290 basis points to 17.1%, but adjusted operating margins for the year held flat at a strong 20%. As we’ve said before, the project activity that we’ve seen in the Pump Division should yield opportunity in the Seal Division.

The next two charts provide detail on our realignment initiative, which I will not go into detail. Year-to-date we’ve seen $29.6 million of expense, and for the year we are forecasting $39.6 million, as indicated on slide 30. Most important, what we expect to see is an annual $56 million run rate on these initiatives.

Turning briefly to slide 31, primary working capital, you can see that we’ve improved our year-over-year primary working capital, with the increases in receivables and inventory coming from the Pump Division. Primarily in inventory, we’ve seen an increase in work-in-process as we build these projects for future delivery.

Turning to slide 32 on cash flows, as we mentioned earlier, we’re very pleased with our $102 million of operating cash flow. We invested $49 million in our business in the CALDER acquisition and capital expenditures, including the Middle East and nuclear capabilities, and we returned $24 million to the shareholders in the form of dividends and share repurchases.

Slide 33 will remind everyone that we have a very strong balance sheet with $578 million of cash and available credit capacity.

Turning to slide 34, 2009 uses of cash, in capital expenditures we’ve spent $64 million and we still project capital expenditures to be around $100 million this year. We’ve paid three quarterly dividends. We repurchased $16.2 million of shares and still have $119 million available in our approval. We expect $50 million to $80 million of pension fund contributions, and up through this point have contributed $46 million of that. We’re going to spend money on realignment and continue to look for strategic acquisition opportunities like the one mentioned earlier at CALDER.

So looking forward, as Lew said, we’re very pleased to raise our 2009 full year earnings per share target range to between $7.15 and $7.75, driven by performance and the weakening dollar during the course of the year. The company is very well positioned to capture aftermarket business and has a solid project backlog. Now while we are taking out costs, we are investing in growth initiatives, like the Integrated Solutions Group, our CALDER acquisition, new Brazilian operation, Middle East joint ventures, and Asia-Pacific QRCs. We are very pleased with our cash flow, especially when you consider that historically the back half of the year is our strongest cash flow period.

Our realignment should create a more efficient operating platform. As I mentioned earlier, we see $56 million of systemic benefits in our business from these initiatives. Also we will stay focused on continued SG&A reduction. The bottom line is that management is pleased with our results and how this company is positioned going forward.

With that, I will turn it back to Paul for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Kevin Maczka with BB&T Capital.

Kevin Maczka - BB&T Capital

I guess I’ll ask my first question around these margin goals. Your operating margin goal of 15%, obviously you are handily ahead of that already. The 20% SG&A margin goal, maybe you could have hit that already if you weren’t spending on growth initiatives. But can you just comment directionally on that? Does your guidance increase suggest that maybe you will be closer to that level in the back half of the year?

Mark Blinn

We set out as a target for 2010. I think, to your point, 20.5% on an adjusted basis, we’ve made substantial progress to that. What we can say and I think you’ve picked up on an important point, we’re going to continue to invest where we think we see strategic opportunities. So as you look at our comment around the guidance on the back half of the year, it is continued performance that you’ve seen the likes of. Also to point out, we have seen relative to the guidance in the beginning of the year a weakening dollar, which has provided a benefit. So what I would say is the goal still stands out there as one we expect to achieve and we set out for in 2010 and we’re continuing to drive that going forward.

Kevin Maczka - BB&T Capital

Just to follow-up on the backlog. The orders, the backlog, impressive given the later cycle nature of the business to see those improve like they did. The book-to-bill around 1. So I guess my question is, do you expect to burn more of that backlog in the second half? Or with your commentary about the pump orders potentially leading the valve and seal orders higher as well, is it your expectation that you will maintain that backlog in the back half as well?

Mark Blinn

That’s kind of a roundabout way of getting bookings guidance going forward, which we don’t give. But let me just give you a better clarity and understanding on what’s going on. When you look at bookings, backlog, sales and cancellations, that really captures what’s happening in our business. As Lew mentioned, we’ve had very little in cancellations. What you are seeing in our backlog and we talked about this last year is these are very complex, long lead-time projects that you’ve seen that are working through our backlog right now, and so that’s kind of what you’ve seen. You’ve seen that aspect in the book-to-bill, but more importantly you’ve seen the strong bookings that we’ve reported. We’ve been very pleased with our bookings now for the last three quarters, all things considered.

So going forward, what I’d like to refer to as Lew’s market comments, I think our discipline around how we take business in, and that should give you information that you can make your own determination of what you think the book-to-bill is going to be going forward.

Operator

Your next question comes from the line of Hamzah Mazari from Credit Suisse.

Hamzah Mazari - Credit Suisse

Could you talk a little bit about what business lines and end markets you’re gaining share? You compete with just a handful of players in an industry that’s pretty fragmented. Are you gaining share from the larger guys on a specialized side of your business, or are you gaining share from sort of Tier 2 players? What’s driving that essentially?

Lew Kling

Hamzah, it’s really both. As we’ve talked about before, the strong balance sheet becomes ever present with regard to the Tier 2 players. We’ve talked about the strength in our balance sheet. Having said that, if you look at our global presence, you look at our aftermarket capabilities, that’s what gives us the belief that we are gaining share against the large competitors as well.

Hamzah Mazari - Credit Suisse

Just a follow-up on the SG&A. You guys have talked about 200 basis points of additional costs takeout. Can you just repeat for us, has that process already begun, or is that 200 basis points additional room and cushion for you to run on?

Mark Blinn

Yes, Hamzah, I’m not sure what you’re referring to in the 200 basis points. I think what we commented on that was when our SG&A was at 22% on a reported basis, and we said look, our bogey is 20, so it’s 200 basis points. Certainly you saw some progress about that. One thing that’s important is we’re not saying, structurally, 20% is our business. Once again, we’re going back to a couple of years where we set a target for a period of time and we measure ourselves against that.

Our focus is around taking costs out of our business where we have the opportunity, but also reinvesting around strategic opportunities. The Integrated Solutions Group has been a significant capital and SG&A investment for this company, has also been the build-out in India and the Middle East. We’re adding resources there. So I think my general comment is, we’ll stay focused on costs. We think we still have plenty of opportunity in terms of our cost structure. We reinvest where we think it’s appropriate.

Hamzah Mazari - Credit Suisse

Just lastly, could you comment on how much more linked your valve and seal business is to chemicals and general industrials versus your overall mix?

Mark Blinn

As we talked about even last year, because if you look at the valve business, they have what we call kind of a boomer of a quarter in the second quarter last year in the chemical industry, and you’ve seen that as one that’s been the hardest hit. They’ve always had great execution and great penetration in the chemical industry worldwide. We’ve talked about we’ve seen the impact in Europe and the U.S. So they’re linked, but also they’re expanding. The valve business has been expanding their opportunities in oil and gas. As we talked about on the order today, you saw in the nuclear, they are ever-present in the nuclear capabilities around the world. The same thing in the seal business. I think when you look at our business, historically, yes, we’ve had strong penetration in the chemical industry, but we’ve been working very hard at expanding our sector base over the last couple of years.

Operator

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

Scott Graham - Ladenburg Thalmann

I wanted to ask a couple of questions about the aftermarket business. I think, first, if you could tell me kind of how the bookings progressed in the quarter. You indicated that they improved late in the first quarter. I’m wondering if you saw improvement as the quarter progressed, and in particular the pumps aftermarket.

Mark Blinn

We talked about what had occurred in the first two months of the first quarter and that we’d seen a lot of that debate during the end of the first quarter and beginning of the second quarter. So we saw continued improvement in the aftermarket bookings, because some of the dynamics that we talked about earlier is that you can certainly delay some maintenance, but you can’t delay it forever. So those things started certainly coming back on line. But also what you saw on our growth as well is we’re starting to get some tractions in our Integrated Solutions Group and some of the other initiatives as well.

So it was a combination. We did see progress. We always caution people we are not a quarter-to-quarter business. The greatest example is that nuclear order we got today. That would change everybody’s commentary around valves if that would have been in the last quarter, but the fact is we’re not a quarter-to-quarter business but we have seen good, steady progress in our aftermarket business.

Scott Graham - Ladenburg Thalmann

It looks to me as if production capacity utilization however we want to define, the influence is on aftermarket on a global basis, since everything is a click lower today than it was a year ago, yet your aftermarket business is up year-over-year. It would suggest some share gain. I’m wondering if you could maybe share with us sort of your end-user strategy on pumps. Now, you’ve been shipping a lot of pumps for a long time now, four or five years. I’m just wondering if, in fact, you have any idea of what your win rate on your pumps aftermarket business is right now.

Mark Blinn

Yes, we’ve talked about it before as the capture rate, and it has gone up. We’ve talked about years ago we saw it in the low 30s and it’s probably in the high 30s or low 40s at this point in time. But that is part of the equation. When we talk about share gain, it’s capturing the installed base that we’ve put in. As Lew commented, a lot of that we are going to be able to harvest that starting towards really the middle or the back half of this year as it comes out of warranty.

Part of it also is going back in and capturing installed base that we lost many years ago, but a more important way to think of our business of share gain along the lines certainly of our competitors, also the term people have talked about the pump pirates, which are the local machine shops, but also where we get a lot of shares, especially in our alliance agreements, are from customers themselves. We’ve seen benefits really across all of those fronts. If you think about it, we’ve got a lot of installed base. We are the original equipment manufacturer. We have the drawings. We have the capabilities. They are going to want to put their service to us. That also applies to what I’d call the local machine shops as well. They’ll replicate; we will duplicate. There is a significance around that in terms of performance of the equipment.

Also on the customers, as we talked about, they are looking to outsource a lot of their fixed costs around maintenance, and we are there to provide that service to them. So really that’s how you’re seeing the growth here. We don’t want to only tie it to incremental installed base, because the story is much broader than that really in all of our three divisions. It’s not just isolated to pumps.

Operator

Your next question comes from the line of Karen Finerman with Metropolitan Capital.

Karen Finerman - Metropolitan Capital

Very nice quarter. We’ve seen some high profile delays from Petrobras. Does that affect you?

Mark Blinn

Very little. They had four refineries that they had on the map. One they are moving forward with. Now, some of them they may push out to future periods, but you can see from some of the announcements we had out over the last two or three months, Petrobras remains a very, very key customer, not only on the project side, but also great opportunity on the aftermarket side. We’ve been building out a lot of our capabilities down in Brazil.

Karen Finerman - Metropolitan Capital

Can you give us any sense of, is it significant for earnings or no?

Mark Blinn

The good thing is not any one of these projects are going to make a material difference to our earnings. But in the aggregate, these projects are all very important. Petrobras is a very important customer. We’ve really seen them ramp up for us over the last couple of years, especially with our committed investment in the region.

Karen Finerman - Metropolitan Capital

So do you expect, just looking at your pie chart as a geography, that Latin America piece to grow meaningfully over the next two or three years?

Mark Blinn

From a personal standpoint, I certainly hope so. Yes, I am a little bit biased here.

Karen Finerman - Metropolitan Capital

It was your baby.

Mark Blinn

Yes, it is. It is. I mean, oftentimes people don’t refer to that as an emerging area because it’s been around for a long time. We’ve had a long standing presence in that region, but if you look at what’s happening to the economies and as you well know, Brazil is now investment grade. I mean, who would have thought that ten years ago? Their economies are starting to grow, we are seeing good growth in Colombia and in areas like that. I do think that that’s going to continue to be a growth area, along with China, along with India and the Middle East. So those four may start to overtake the U.S. But I do, I think we see good growth opportunities in Latin America, and that’s why we’re making an investment down there.

Operator

Your next question comes from the line of Jamie Sullivan with RBC Capital Management.

Jamie Sullivan - RBC Capital Management

A question on the bookings side. You mentioned that these were long lead time projects in the pumps business. Are you seeing some of this in the projects that were being re-bid or re-budgeted, as you describe it? Are you seeing those being led? Is that what’s happening or are these just long lead time projects? That would be the first part. The second part would be about lead times in general, what you’re seeing in the pipeline. Are those changing at all?

Mark Blinn

On the first question, we are seeing both. These complicated projects have had long lead times. We talked about this last year, as people were trying to understand better how our bookings converted to sales. Now the important thing is looking forward. As we’ve talked about before, on any project time is money. So the project management is going to be looking for ways to tighten down the project timeline. That’s going to hit the sweet spot of companies around on-time delivery, which we’ve talked about our excellence in on-time delivery for a long period of time.

So what I would say is the way the supply base was, even eight months ago what they were doing is quoting longer lead times and you’re seeing how that moves through our backlog. I think, on your second question on large projects. We are starting to see, as Lew talked about, they are starting to let them. But going forward, what they’re going to do is they are going to look for shorter lead times to try to reduce the overall project cost. That will play right into our hands.

Jamie Sullivan - RBC Capital Management

Okay. Are you seeing that in your pipeline and bid activity now, the shorter lead times?

Mark Blinn

Yes.

Jamie Sullivan - RBC Capital Management

Okay, great. Then my second question was just on the Integrated Solutions Group. You’ve talked about that a little bit. Can you give a few more details there on kind of how that changes, how you go to market at all, and how you’ve seen some success there so far?

Mark Blinn

We were doing this. We launched this at the beginning of the year. Actually in our discussions around this call what we’ve talked about is we really wanted to talk about this on our next call, because it’s still early stages. But it is around what it says; it’s integrated solutions. It’s around providing reliability and efficiency to the customer and information so that he understands how his systems are running and how profitable it is. That’s a general way to summarize it, but we will be talking about it more and more going forward because we are very excited about it.

Operator

Your next question comes from the line of Mike Schneider with Robert W. Baird.

Mike Schneider - Robert W. Baird

First just an incredible quarter and kudos to you, just great execution. I guess first question is just starting at the macro level. If you look at the guidance, ex the restructuring, you’ve basically earned about $4 in the first half. The guidance would be for something roughly similar or slightly higher in the second half. Just conceptually, will you see the typical seasonality or frankly even more, given that the first quarter was kind of starting in a hole with the global economy? It strikes me that the back half guidance, even at the high end, is low.

Mark Blinn

That’s a fair point, but one of the things that you’ve got to consider is around currency and a lot of it is what could happen in the marks of our currency. We’ve certainly seen, on an unexpected basis, the dollar has weakened over the period of time, so part of that going forward. The other thing is we estimate benefits to be received by the realignment, but we are going to want to see them progress through over the course of the year as we refine our guidance going forward. We thought you’d be happy when we took the guidance up. There’s not too many companies doing that at this point.

Mike Schneider - Robert W. Baird

I’m very happy and I guess I am even calling it that it looks low.

Mark Blinn

Mike, if nothing else, you have been consistent.

Mike Schneider - Robert W. Baird

I have been. You’ve come up to meet my numbers, but now I am considering that the second half, you are starting with record margin momentum coming out of this quarter. You’ve got lower restructuring costs, lower raw materials. Yes, currency is becoming a headwind, but it strikes me that seasonality alone and those tailwinds and the backlog only down 12% strikes me again that the guidance doesn’t really account for any of that.

Mark Blinn

One of the things that I saw in your comment around revenue, keep in mind these longer lead time projects, there’s more in the stability around the book-to-bill. There tends to be more stability around our sales on a currency neutral basis during the course of the year. That’s kind of what you’re seeing in terms of how we manage our load and our projects, and also the growth of our aftermarket business.

I am not calling a revenue trend going forward, but it’s just something to think about in our business, is historically what you saw is a substantial amount of sales in the fourth quarter. That may be what you’re looking at historically. Just keep in mind, longer lead time projects, more of a mix on the aftermarket business which tends to be more steady.

Mike Schneider - Robert W. Baird

Got it. Then in the backlog, if you look at and focus even on pumps specifically, can you talk about multipliers that are embedded in the backlog versus what we are shipping today, just so we can get a sense of are these margins sustainable as you begin to ship the backlog that’s in place today?

Mark Blinn

We don’t comment specifically on multipliers. We commented earlier on the call that, as you noted, we saw an impact certainly on pricing out there. But the point is we are also able to turn to our supply base and drive that as well. So we maintain discipline around how we approach margins in our business. But as you commented and as we’ve said before, we certainly see the impact of pricing. But what you also see going on is we are able to manage our supply base. You can see the continuous improvement in our operating platform. Also look around aftermarket growth and mix, and all those things factor into how you should look at margins going forward.

Mike Schneider - Robert W. Baird

Qualitatively, are multipliers in the backlog today similar to what they were six months ago?

Mark Blinn

Again, I don’t want to comment specifically on multipliers, because that is obviously very market sensitive data right now, but my comment was around pricing that we talked about on the year end call.

Mike Schneider - Robert W. Baird

Right. Then gross margins again for the enterprise, if you scrub it of restructuring, they were flat sequentially at 36.5%. I’m curious. You’re further along into the restructuring, so you’re getting some savings. The aftermarket shifted even more so this quarter. Why wouldn’t we have seen gross margins? I hate to even pull out a negative here, because it’s an incredible quarter, but why wouldn’t gross margins have expanded sequentially?

Mark Blinn

Let me flip through my deck real quick to respond to one of your comments. Actually consolidated gross margins had an impact in the quarter. They were reported at 35.4%. You’re right, but that had a 110 basis point impact from realignment. So we’ve still seen certainly some leverage in there around the gross margins. So good gross margin improvement, and I guess I am kind of missing the point there of what you’re trying to say.

Mike Schneider - Robert W. Baird

If Q1 had 60 points of impact from restructuring, so the reported number of 35.9% would have been 36.5% as well. So just sequentially, margins ex-restructuring, were at 36.5%, 36.5%. I am just curious again. The aftermarket certainly would have been beneficial. Some early savings would have been beneficial. Is there something about the mix that I’m missing?

Mark Blinn

No, no, nothing. By the way, we saw very little savings in the gross margin. We expect to see certainly more, but no, I don’t think there’s anything other there. The 36.5% adjusted margins, gross margins, are very high in our business.

Mike Schneider - Robert W. Baird

Yes, not taking anything away from you. Then aftermarket, we’ve heard some companies discuss how, as your customer base begins to take plants down, in particular in chemical, that even their service contracts are being canceled. Have you seen any impact in your aftermarket business from that type of cancellations?

Mark Blinn

A lot of that you’ve already seen in the numbers in the seal business in the first half of the year. We’ve seen the impact of certainly shuttering some of those plants, and as we’ve talked about before, it’s not determined at this point if and when they’re going to bring those facilities back up.

Having said that, an example is we built out a QRC in Vietnam because they are putting a petrochem facility there. So in one area where they are taking capacity down and moving it to other regions of the world, that’s where we are to capture that business. But yes, it is fair to say that certainly in the U.S. chemical sector, primarily in our Seal division, we’ve seen the impact of them taking this capacity down. A lot of that is already in our numbers.

Operator

Your next question comes from the line of Charlie Brady with BMO Capital Markets.

Charlie Brady - BMO Capital Markets

I just wanted to look at, on the Pump Division, when you look at the sales mix, the OE and aftermarket, obviously it went against you by about 5%, which normally would be a negative on margins, but clearly that’s not the case in this quarter. So I guess I’m trying to understand the old rule of thumb aftermarket to OE, aftermarket being maybe three times better on a gross margin basis. Looking at this, is it fair to assume that over time that that spread between OE and aftermarket has narrowed, so maybe that rule of thumb of 3X is not valid because the OE side, particularly on a pricing standpoint, has gotten better?

Mark Blinn

Yes, and the execution on the OE has gotten better. I think everybody needs to understand that’s probably one of the most important thing. We were years ago having trouble realizing margin on projects, as much of that was our fault as it was the environment. But you’re right. We’ve used the rule of thumb of 30 basis points for a 100 basis point shift in the mix, and so your point is well taken. I think this goes to Mike’s question perhaps earlier, is what you’re seeing is our ability to execute very well on these projects, and our discipline around price and that’s what supported the margin growth, so despite a mix shift against us in the Pump Division and overall.

Charlie Brady - BMO Capital Markets

Right. Just speaking generally on margins, can you give us a sense of how much of this margin improvement, which was stellar, how much of that is price and really how much is execution on the margin improvement?

Mark Blinn

Yes, it’s a consistent story that we’ve been talking about for a while. Most of what you’re seeing in the improvement in our business is around operational excellence, cost initiatives; you’re starting to see some of the beginning benefits of the realignment. It’s really around the platform, and that’s why we highlight the platform so much in our discussions. We are certainly, relative to a couple of years ago, seeing the benefit of price in our margins as well. That’s why continued improvement of our platform is critical.

Charlie Brady - BMO Capital Markets

If you look at the bookings coming in today, given that raw materials have come down and there’s been some deflation, has pricing pulled back at all?

Mark Blinn

Yes. Again, at the beginning of the year we talked about it. We certainly were starting to see pressure on pricing. A lot of it was driven by raw materials. Project managers see raw materials costs go down 40%, 50% and they look to their suppliers to pass some of that benefit through. But when you take a step back, something you need to think about is a lot of what we get paid for is the engineering, and we don’t necessarily discount our engineering capabilities. But in a large pump, for example, 30% of that can be the motor. A lot of the price of that motor can be impacted by commodity prices out there. But historically, we haven’t made lot of margins on just passing through a motor. A customer won’t let you do that.

Operator

Your next question comes from the lines of William Bremer with Maxim Group.

William Bremer - Maxim Group

I thank you for providing some color on the installed base coming out of warranty. This is something that we’ve been highlighting to the Street since our initiation. My colleagues did a great job on firming up bookings and backlog, etc., there. I saw some news recently regarding the oil sands projects, particularly a pretty large one opening up, first one most recently coming to the forefront here. We do know that you play into a few with those two customers there that are working on that. In particular then, a deepwater drill going down approximately 7,200 feet has been announced. I just want to get a feeling of how this falls favorably into your mix.

Mark Blinn

It’s opportunity. As you saw towards the end of last year when oil dropped precipitously, a lot of people were questioning the tar sands. Some people announced that they were halting future projects at that point. But a lot of that started coming back online over the last couple of months, because if you look at it, it is a viable source of the resource and they are able to cost justify it going forward. You’ve seen that with some of the pairings, Total and Suncor. They are really focused on driving investment going forward, and that’s where we are very well positioned. As we’ve talked about, we have some specialty equipment that goes in there that really helps reduce the cost in the overall process.

William Bremer - Maxim Group

Can you give us an idea of how many competitors are at those tables competing in that highly engineered activity?

Mark Blinn

It’s relatively few, about three. When you look to some of these complex applications, as you go up the complexity curve, the competitive landscape tends to narrow. But it’s about three in the tar sand area.

William Bremer - Maxim Group

Okay, great. Then possibly a little color on the deepwater drilling?

Mark Blinn

That certainly is an opportunity for us on the deepwater drilling side. If you’re talking about the offshore, one mile to two miles down to the subsea platforms, those are very complicated platforms. They have to be designed not to fail. Again, that plays right into our sweet spot. So that’s opportunity for us in some of the deepwater platforms that are going to go down, very expensive platforms.

Operator

We have a follow-up question from the line of Mike Schneider with Robert W. Baird.

Mike Schneider - Robert W. Baird

All right, guys. On the pricing question, so pricing is coming down with raw materials and just slack capacity. So if we look at the pump orders basically being flat year-on-year, if pricing is even down 10%, it implies that volumes are up an equal amount. I guess is that accurate? I guess what would explain the volumes actually being up year-over-year, given that a year ago was obviously a very peak period?

Mark Blinn

Share gain, Mike.

Mike Schneider - Robert W. Baird

Okay.

Mark Blinn

That’s it.

Mike Schneider - Robert W. Baird

Okay. Then in terms of just pent-up orders, so Q4 and Q1, the world was locked down. I know this is a qualitative question, but do you have a sense of, are orders today just expressing what would have been booked over the last six months such that this is kind of a misleading period where we are booking six months of orders in three months? Or does your global database of projects show that this is really a sustainable level of projects and orders?

Mark Blinn

Yes, when we look across the project opportunities, there’s good project opportunities out there. The question is, are we kind of seeing a backlog of opportunities come flushing through? They don’t come through on large projects like this. What they tend to do, when they delay them is they delay them and they kind of stay in the queue over a regular period of time. Now, what does change is their delivery dates. Again, I think that’s been part of the opportunity as to why we have been successful in gaining share. So, no, you are not seeing kind of a wave come through that has been pent-up demand. That doesn’t happen in large projects; that doesn’t happen at all in large projects.

Mike Schneider - Robert W. Baird

Okay. Then a final question just, is there anything unusual in the Q2 orders, like the thruster orders of a year ago, that we will be talking about a year from now?

Mark Blinn

No, there’s nothing really that we will be lapping in terms of unique items. The reason we highlight those thruster orders is those were very event driven opportunities. We hadn’t really seen opportunities like that in 10 to 15 years. So we just wanted to call them out as helping people understand that really you capitalize on some capacity we had in Germany for a very specific need.

Operator

(Operator Instructions). Your next question comes from the line of Scott Graham with Ladenburg Thalmann.

Scott Graham - Ladenburg Thalmann

I just wanted to ask one follow-up question, because as I’m sitting here listening to the Q&A, I am also doing some modeling. You guys have this great problem of liquidity on your balance sheet. I know that you’re looking for acquisitions and I know you want to invest inside the core businesses and what have you. But you can kind of do all of that with change to spare. I’m wondering if we start to see, with the credit markets a little bit more stable now, perhaps a lot more stable, if there is a share repurchase acceleration that’s being contemplated. I know that now you’re not going to answer that question specifically, but obviously you don’t want to end 2010 with $400 million to $500 million of cash on the books. What’s the thinking?

Mark Blinn

You’re right. I am not going to answer your question on the share repurchase. You know me well. But I think, again, think about how we look at a share repurchase. It is a good systematic way to return value to the shareholder along with the dividend. It’s only six months ago that if we would have told everybody that we were going to have whatever you mentioned, $0.5 billion of cash or $0.6 billion on our balance sheet, it would have received a round of applause at the end of the year.

So market conditions have changed. Our credit markets, specifically to Flowserve, are good and along those lines, but it’s the way we think about our cash and our balance sheet going forward. We definitely want to use it strategically. Along our lines of thinking, if we thought that the best way to use that was to return more value to the shareholder, we would do that.

But also keep in mind that as these markets start feeling the impact and as companies out there start to differentiate themselves, as we’re doing, that really raises the level of strategic acquisition opportunities. We don’t really want to foreclose anything. One of the things we’ve learned from our past is when we are highly leveraged or we don’t have a flexible balance sheet, it really does limit our options. We don’t want to be in that position again.

Operator

You have no further questions.

Paul Fehlman

Okay. Then I would like to remind everybody that this webcast will be available on our website for a replay in approximately two hours. Thanks everyone for joining us on the call today.

Operator

Ladies and gentlemen, this concludes today’s Flowserve second quarter 2009 release conference call. You may now disconnect.

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Source: Flowserve Corp. Q2 2009 Earnings Call Transcript
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