Cameron International Corporation--Quarterly Report for the Quarterly Period Ended June 30, 2007
Table of Contents
 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

(Mark One)
  
 
R
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended June 30, 2007
 
OR
 
£
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-13884

Cameron International Corporation
(Exact Name of Registrant as Specified in its Charter)

Delaware
76-0451843
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)
   
1333 West Loop South, Suite 1700, Houston, Texas
77027
(Address of Principal Executive Offices)
(Zip Code)

713/513-3300
(Registrant’s Telephone Number, Including Area Code)

N/A
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes R No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check one)

Large accelerated filer R Accelerated filer £ Non-accelerated filer £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes £ No R

Number of shares outstanding of issuer’s common stock as of July 25, 2007 was 108,733,396.
 

TABLE OF CONTENTS

 


2

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

CAMERON INTERNATIONAL CORPORATION
CONSOLIDATED CONDENSED RESULTS OF OPERATIONS
(dollars and shares in thousands, except per share data)

 
Three Months Ended
June 30, 
  
Six Months Ended
June 30, 
  
 
2007 
  
2006 
  
2007 
  
2006 
  
 
(unaudited)
  
(unaudited)
  
REVENUES
$1,139,042
  
$857,765
  
$2,136,092
  
$1,687,425
  
COSTS AND EXPENSES
Cost of sales (exclusive of depreciation and amortization shown separately below)
792,130
  
582,909
  
1,486,046
  
1,167,904
  
Selling and administrative expenses
143,226
  
124,597
  
269,329
  
250,260
  
Depreciation and amortization
27,134
  
24,605
  
52,985
  
47,241
  
Interest income
(6,284
 ) 
(4,651
 ) 
(17,268
 ) 
(7,779
 ) 
Interest expense
6,031
  
4,295
  
12,805
  
7,541
  
Acquisition integration costs
—
  
9,083
  
—
  
19,112
  
Total costs and expenses
962,237
  
740,838
  
1,803,897
  
1,484,279
  
Income before income taxes
176,805
  
116,927
  
332,195
  
203,146
  
Income tax provision
(53,577
 ) 
(40,963
 ) 
(107,963
 ) 
(71,140
 ) 
Net income
$123,228
  
$75,964
  
$224,232
  
$132,006
  
Earnings per common share:
                
Basic
$1.13
  
$0.67
  
$2.03
  
$1.15
  
Diluted
$1.08
  
$0.64
  
$1.95
  
$1.11
  
Shares used in computing earnings per common share:
                
Basic
109,365
  
114,184
  
110,188
  
115,087
  
Diluted
114,407
  
117,812
  
114,773
  
118,467
  


The accompanying notes are an integral part of these statements.


3
CAMERON INTERNATIONAL CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(dollars in thousands, except shares and per share data)

 
June 30,
2007 
  
December 31,
2006 
  
 
 (unaudited)
      
ASSETS
        
Cash and cash equivalents
$467,393
  
$1,033,537
  
Receivables, net
765,870
  
696,147
  
Inventories, net
1,309,352
  
1,009,414
  
Other
166,564
  
168,554
  
Total current assets
2,709,179
  
2,907,652
  
Plant and equipment, net
718,515
  
648,785
  
Goodwill
643,683
  
595,268
  
Other assets
226,767
  
199,045
  
TOTAL ASSETS
$4,298,144
  
$4,350,750
  
         
LIABILITIES AND STOCKHOLDERS’ EQUITY
        
Current portion of long-term debt
$7,824
  
$207,345
  
Accounts payable and accrued liabilities
1,513,742
  
1,364,716
  
Accrued income taxes
29,716
  
56,151
  
Total current liabilities
1,551,282
  
1,628,212
  
Long-term debt
746,960
  
745,408
  
Postretirement benefits other than pensions
20,299
  
20,757
  
Deferred income taxes
83,455
  
90,248
  
Other long-term liabilities
126,186
  
124,686
  
Total liabilities
2,528,182
  
2,609,311
  
Commitments and contingencies
—
  
—
  
Stockholders’ Equity:
        
Common stock, par value $.01 per share, 150,000,000 shares authorized, 116,170,863 shares issued at June 30, 2007 and December 31, 2006
1,162
  
1,162
  
Capital in excess of par value
1,141,013
  
1,140,765
  
Retained earnings
980,194
  
760,958
  
Accumulated other elements of comprehensive income
55,247
  
16,326
  
Less: Treasury stock, 7,485,852 shares at June 30, 2007 (3,881,236 shares at December 31, 2006)
(407,654
 ) 
(177,772
 ) 
Total stockholders’ equity
1,769,962
  
1,741,439
  
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$4,298,144
  
$4,350,750
  

The accompanying notes are an integral part of these statements.

4

CAMERON INTERNATIONAL CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(dollars in thousands)

 
Three Months
Ended June 30, 
  
Six Months
Ended June 30, 
  
 
2007 
  
2006 
  
2007 
  
2006 
  
 
(unaudited)
  
(unaudited)
  
Cash flows from operating activities:
                
Net income
$123,228
 
$75,964
 
$224,232
 
$132,006
  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Depreciation
20,050
 
19,563
 
39,400
 
37,378
  
Amortization
7,084
 
5,042
 
13,585
 
9,863
  
Non-cash stock compensation expense
7,651
 
4,646
 
14,189
 
11,395
  
Non-cash write-off of assets associated with acquisition integration efforts
—
 
4,275
 
—
 
10,810
  
Tax benefit of employee benefit plan transactions, deferred income taxes and other
(7,902
)
24,836
 
11,784
 
33,752
  
Changes in assets and liabilities, net of translation, acquisitions and non-cash items:
                
Receivables
(61,803
)
(20,726
)
(50,966
)
(47,526
 ) 
Inventories
(124,409
)
(95,170
)
(271,539
)
(204,815
 ) 
Accounts payable and accrued liabilities
81,184
 
117,923
 
113,851
 
174,789
  
Other assets and liabilities, net
(27,609
)
(28,203
)
(40,279
)
(45,930
 ) 
Net cash provided by operating activities
17,474
 
108,150
 
54,257
 
111,722
  
Cash flows from investing activities:
                
Capital expenditures
(55,014
)
(43,596
)
(107,973
)
(73,656
 ) 
Acquisitions, net of cash acquired
(31,714
)
—
 
(75,658
)
(34,659
 ) 
Proceeds from sale of plant and equipment and other
1,953
 
1,524
 
3,624
 
3,240
  
Net cash used for investing activities
(84,775
)
(42,072
)
(180,007
)
(105,075
 ) 
Cash flows from financing activities:
                
Loan repayments, net
(207,155
)
(164
)
(199,148
)
(204
 ) 
Issuance of convertible debt
—
 
500,000
 
—
 
500,000
  
Debt issuance costs
—
 
(8,218
)
—
 
(8,218
 ) 
Purchase of treasury stock
(126,491
)
(207,969
)
(277,362
)
(237,718
 ) 
Proceeds from stock option exercises
13,056
 
21,571
 
22,282
 
33,212
  
Excess tax benefits from stock compensation plans
6,601
 
—
 
11,635
 
—
  
Principal payments on capital leases
(1,623
)
(962
)
(2,621
)
(2,255
 ) 
Net cash (used for) provided by financing activities
(315,612
)
304,258
 
(445,214
)
284,817
  
Effect of translation on cash
1,378
 
7,477
 
4,820
 
9,856
  
(Decrease) increase in cash and cash equivalents
(381,535
)
377,813
 
(566,144
)
301,320
  
Cash and cash equivalents, beginning of period
848,928
 
285,478
 
1,033,537
 
361,971
  
Cash and cash equivalents, end of period
$467,393
 
$663,291
 
$467,393
 
$663,291
  

The accompanying notes are an integral part of these statements.


5

CAMERON INTERNATIONAL CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Unaudited

Note 1: Basis of Presentation

The accompanying Unaudited Consolidated Condensed Financial Statements of Cameron International Corporation (the Company) have been prepared in accordance with Rule 10-01 of Regulation S-X and do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. Those adjustments, consisting of normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the financial information for the interim periods, have been made. The results of operations for such interim periods are not necessarily indicative of the results of operations for a full year. The Unaudited Consolidated Condensed Financial Statements should be read in conjunction with the Audited Consolidated Financial Statements and Notes thereto filed by the Company on Form 10-K for the year ended December 31, 2006.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates include estimated losses on accounts receivable, estimated realizable value on excess or obsolete inventory, estimated liabilities for contingencies, including among other things, liquidated damages and environmental, legal, regulatory and tax matters, estimated warranty costs, estimates related to pension accounting, estimated proceeds from assets held for sale and estimates related to deferred tax assets and liabilities, including valuation allowances on deferred tax assets. Actual results could differ materially from these estimates.

Certain of the Company’s contracts, particularly those for large subsea and drilling projects, contain clauses which allow customers to assess liquidated damages in the event of late delivery by the Company. Many of these contracts require that financial harm to the counterparty must result from the Company’s failure to deliver equipment on time before the Company can be held liable for any liquidated damages. As of June 30, 2007, the Company has failed to meet contractual delivery dates for certain of its products which could expose the Company to liability for liquidated damages. In those instances where the contract allows for nonpayment of liquidated damages where no financial harm has occurred and where the Company has concluded that no financial harm has been caused to its customers, no accruals for contractual penalties have been made. However, the Company’s estimate of the financial impact on its customers of not delivering product in accordance with the contractual terms could change based on additional information being received in the future from its customers.

Note 2: Acquisitions

During the first quarter of 2007, the Company acquired DES Operations Limited (DES), a Scotland-based supplier of production enhancement technology at a cash cost of approximately $37,679,000, plus a maximum additional contingent payout of approximately 4.0 million British Pounds depending on the financial performance of DES over the next three years. The acquisition of DES enhances the Company’s subsea product offerings within the Drilling & Production Systems (DPS) segment by providing technology that allows for subsea processing capabilities directly on a subsea tree. Additionally, the Company acquired certain assets of Prime Measurement Products (Prime), a supplier to the measurement business of the Valves & Measurement (V&M) segment. The total cost of this acquisition was approximately $6,265,000.

On April 2, 2007 the Valves and Measurements segment completed the purchase of certain assets and liabilities of Paradigm Services, LP, a Texas-based valve and actuator repair and remanufacturing business, at a cash cost of $10,232,000, of which approximately $8,750,000 was paid at closing with the remainder due by September 2008. Additionally, on June 5, 2007, the Company purchased the Hydromation Deep Bed Filter product line from the Filtra-Systems Company, a Michigan-based supplier of filter solutions, at a cash cost of approximately $21,482,000. This business was a supplier to the DPS segment’s oil, gas and water separation applications product line.

All acquisitions were included in the Company’s consolidated condensed financial statements for the period subsequent to each acquisition. Preliminary goodwill recorded as a result of these acquisitions totaled approximately $52,744,000 at June 30, 2007, approximately 30% of which will be deductible for income tax purposes. The Company is still awaiting significant information relating to the fair value of the assets and liabilities of the acquired businesses in order to finalize the purchase price allocations.
 
6

 
Note 3: Receivables

Receivables consisted of the following (in thousands):

 
June 30,
2007 
  
December 31,
2006 
  
Trade receivables
$723,286
  
$671,343
  
Other receivables
50,046
  
32,107
  
Allowances for doubtful accounts
(7,462
 ) 
(7,303
 ) 
Total receivables
$765,870
  
$696,147
  

Note 4: Inventories

Inventories consisted of the following (in thousands):

 
June 30,
2007 
  
December 31,
2006 
  
Raw materials
$113,508
  
$108,889
  
Work-in-process
399,125
  
300,970
  
Finished goods, including parts and subassemblies
912,191
  
687,088
  
Other
6,153
  
4,721
  
 
1,430,977
  
1,101,668
  
Excess of current standard costs over LIFO costs
(69,660
 ) 
(48,031
 ) 
Allowances
(51,965
 ) 
(44,223
 ) 
Total inventories
$1,309,352
  
$1,009,414
  

Note 5: Plant and Equipment and Goodwill

Plant and equipment consisted of the following (in thousands):

 
June 30,
2007 
 
December 31,
2006 
  
Plant and equipment, at cost
$1,474,845
  
$1,365,464
  
Accumulated depreciation
(756,330
 ) 
(716,679
 ) 
Total plant and equipment
$718,515
  
$648,785
  

Changes in goodwill during the six months ended June 30, 2007 were as follows (in thousands):

Balance at December 31, 2006
$595,268
  
Acquisitions
52,744
  
Adjustment to goodwill primarily for the Dresser Acquired Businesses by the V&M segment based upon a final purchase price allocation
(8,971
 ) 
Translation and other
4,642
  
Balance at June 30, 2007
$643,683
  

Note 6: Accounts Payable and Accrued Liabilities

Accounts payable and accrued liabilities consisted of the following (in thousands):

 
June 30,
2007 
December 31,
2006 
Trade accounts payable and accruals
$508,733
$408,480
Salaries, wages and related fringe benefits
108,111
141,444
Advances from customers
670,222
573,527
Sales related costs and provisions
76,520
78,666
Payroll and other taxes
28,321
30,032
Product warranty
30,043
29,846
Other
91,792
102,721
Total accounts payable and accrued liabilities
$1,513,742
$1,364,716
 
 
7
 
Activity during the six months ended June 30, 2007 associated with the Company’s product warranty accruals was as follows (in thousands):

Balance
December 31,
2006
Net
warranty
provisions
Charges
against
accrual
 
 
 
 
Translation
and other
Balance
June 30,
2007
 
 
 
 
$29,846
$9,282
$(7,197)
 
$(1,888)
$30,043
  

Note 7: Debt

The Company redeemed all $200,000,000 of its outstanding 2.65% Senior Notes on April 16, 2007 using available cash on hand.

Note 8: Employee Benefit Plans

Total net benefit (income) expense associated with the Company’s defined benefit pension plans consisted of the following (in thousands):

 
Three Months Ended
June 30, 
  
Six Months Ended
June 30, 
  
 
2007 
  
2006 
  
2007 
  
2006 
  
Service cost
$2,891
 
$2,026
 
$5,782
 
$4,051
  
Interest cost
7,545
 
5,941
 
15,090
 
11,882
  
Expected return on plan assets
(10,312
)
(7,704
)
(20,624
)
(15,408
 ) 
Amortization of prior service cost
(172
)
(141
)
(344
)
(281
 ) 
Amortization of losses and other
3,668
 
2,654
 
7,336
 
5,308
  
Total net benefit expense
$3,620
 
$2,776
 
$7,240
 
$5,552
  

Total net benefit (income) expense associated with the Company’s postretirement benefit plans consisted of the following (in thousands):

 
Three Months Ended
June 30, 
  
Six Months Ended
June 30, 
  
 
2007 
  
2006 
  
2007 
  
2006 
  
Service cost
$1
 
$2
 
$2
 
$4
  
Interest cost
303
 
395
 
606
 
792
  
Amortization of prior service cost
(96
)
(102
)
(192
)
(205
 ) 
Amortization of gains and other
(270
)
(252
)
(540
)
(504
 ) 
Total net benefit (income) expense
$(62
)
$43
 
$(124
)
$87
  

In June 2007, the Company communicated to employees and beneficiaries that it has elected to terminate its U.S. defined benefit pension plans (the Plans) and replace the benefits offered under the Plans with enhanced benefits under its existing defined contribution plan. The Company expects to distribute the assets of the Plans in two phases. The first phase is expected to occur during the fourth quarter of 2007 and will include former employees who are participants in the Plans. The second phase will include current employees and is expected to occur once all necessary governmental approvals are obtained, which is currently anticipated to be in 2008 or early 2009.

In connection with the termination of the Plans, the Company expects to have to fund an additional $10,000,000 to $15,000,000 to the Plans in late 2008 or early 2009. Additionally, the Company expects to record pre-tax charges totaling approximately $85,000,000 between the fourth quarter of 2007 and the first quarter of 2009. The timing of the charges will correspond with asset distributions from the Plans with the majority of the charge expected to be recorded during the fourth quarter of 2007.


8

Note 9: Business Segments

The Company’s operations are organized into three separate business segments - DPS, V&M and Compression Systems (CS). Summary financial data by segment is as follows (in thousands):

 
Three Months Ended 
  
Six Months Ended 
  
 
June 30, 
  
June 30, 
  
 
2007 
  
2006 
  
2007 
  
2006 
  
Revenues:
                
DPS
$682,899
 
$475,659
 
$1,296,622
 
$910,923
  
V&M
315,546
 
271,496
 
611,389
 
570,535
  
CS
140,597
 
110,610
 
228,081
 
205,967
  
 
$1,139,042
 
$857,765
 
$2,136,092
 
$1,687,425
  
Income (loss) before income taxes:
                
DPS
$109,329
 
$89,146
 
$212,737
 
$166,255
  
V&M
65,122
 
29,532
 
126,894
 
55,355
  
CS
22,996
 
12,789
 
30,278
 
22,523
  
Corporate & other
(20,642
)
(14,540
)
(37,714
)
(40,987
 ) 
 
$176,805
 
$116,927
 
$332,195
 
$203,146
  

Corporate & other includes expenses associated with the Company’s Corporate office in Houston, Texas, as well as all of the Company’s interest income, interest expense, certain litigation expense managed by the Company’s General Counsel, foreign currency gains and losses from certain intercompany lending activities managed by the Company’s centralized Treasury function and all of the Company’s stock compensation expense.

Note 10: Earnings Per Share

The calculation of basic and diluted earnings per share for each period presented was as follows - dollars and shares in thousands, except per share amounts:

 
Three Months Ended
June 30, 
  
Six Months Ended
June 30, 
  
 
2007 
  
2006 
  
2007 
  
2006 
  
Net income
$123,228
 
$75,964
 
$224,232
 
$132,006
  
Add back interest on convertible debentures, net of tax
—
 
1
 
—
 
3
  
Net income (assuming conversion of convertible debentures)
$123,228
 
$75,965
 
$224,232
 
$132,009
 
                 
Average shares outstanding (basic)
109,365
 
114,184
 
110,188
 
115,087
  
Common stock equivalents
1,620
 
1,732
 
1,555
 
1,695
  
Incremental shares from assumed conversion of convertible debentures
3,422
 
1,896
 
3,030
 
1,685
  
Diluted shares
114,407
 
117,812
 
114,773
 
118,467
 
                 
Basic earnings per share
$1.13
 
$0.67
 
$2.03
 
$1.15
  
Diluted earnings per share
$1.08
 
$0.64
 
$1.95
 
$1.11
  

Diluted shares and net income used in computing diluted earnings per share have been calculated using the if-converted method for the Company’s 1.75% Convertible Debentures for the three and six months ended June 30, 2006.

The Company’s 1.5% Convertible Debentures have been included in the calculation of diluted earnings per share for the three and six months ended June 30, 2007 and 2006, since the average market price of the Company’s common stock exceeded the conversion value of the debentures during both periods. The Company’s 2.5% Convertible Debentures have not been included in the calculation of diluted earnings per share for any of the periods as they were antidilutive. During the three and six months ended June 30, 2007, the Company acquired 1,862,400 and 4,672,756 treasury shares at an average cost of $67.89 and $59.35 per share, respectively. A total of 506,239 and 1,068,140 treasury shares were issued during the three- and six-month periods ended June 30, 2007, respectively, in satisfaction of stock option exercises and vesting of restricted stock units.


9

Note 11: Comprehensive Income

The amounts of comprehensive income for the three and six months ended June 30, 2007 and 2006 were as follows (in thousands):

 
Three Months Ended
June 30, 
  
Six Months Ended
June 30, 
  
 
2007 
  
2006 
  
2007 
  
2006 
  
Net income per Consolidated Condensed Results of Operations
$123,228
 
$75,964
 
$224,232
 
$132,006
  
Foreign currency translation gain 1
23,944
 
28,564
 
33,055
 
40,740
  
Amortization of net prior service credits related to the Company’s pension and postretirement benefit plans, net of tax
(166
)
—
 
(331
)
—
  
Amortization of net actuarial losses related to the Company’s pension and postretirement benefit plans, net of tax
2,099
 
—
 
4,196
 
—
  
Change in fair value of derivatives accounted for as cash flow hedges, net of tax and other
2,110
 
8,208
 
2,001
 
9,682
  
Comprehensive income
$151,215
 
$112,736
 
$263,153
 
$182,428
  
____________

1 The “Foreign currency translation gain” relates primarily to the Company’s operations in the United Kingdom, Canada, Norway and Brazil.

The components of accumulated other elements of comprehensive income at June 30, 2007 and December 31, 2006 were as follows (in thousands):

 
June 30,
2007 
  
December 31,
2006 
  
Accumulated foreign currency translation gain
$137,674
  
$104,619
  
Prior service credits, net, related to the Company’s pension and postretirement benefit plans
2,842
  
3,173
  
Actuarial losses, net, related to the Company’s pension and postretirement benefit plans
(91,969
 ) 
(96,165
 ) 
Change in fair value of derivatives accounted for as cash flow hedges, net of tax and other
6,700
  
4,699
  
Accumulated other elements of comprehensive income
$55,247
  
$16,326
  

Note 12: Contingencies

The Company is subject to a number of contingencies, including environmental matters, litigation, regulatory and tax contingencies.

Environmental Matters

The Company’s worldwide operations are subject to regulations with regard to air, soil and water quality as well as other environmental matters. The Company, through its environmental management system and active third-party audit program, believes it is in substantial compliance with these regulations.

The Company is currently identified as a potentially responsible party (PRP) with respect to two sites designated for cleanup under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) or similar state laws. One of these sites is Osborne, Pennsylvania (a landfill into which a predecessor of the CS operation in Grove City, Pennsylvania deposited waste), where remediation is complete and remaining costs relate to ongoing ground water treatment and monitoring. The other is believed to be a de minimis exposure. The Company is also engaged in site cleanup under the Voluntary Cleanup Plan of the Texas Commission on Environmental Quality at former manufacturing locations in Houston and Missouri City, Texas. Additionally, the Company has ceased operations at a number of other sites which had been active for many years. The Company does not believe, based upon information currently available, that there are any material environmental liabilities existing at these locations. At June 30, 2007, the Company’s consolidated balance sheet included a noncurrent liability of approximately $6,300,000 for environmental matters.

Legal Matters

In 2001, the Company discovered that contaminated underground water from the former manufacturing site in Houston referenced above had migrated under an adjacent residential area. Pursuant to applicable state regulations, the Company notified the affected homeowners. Concerns over the impact of the underground water contamination and its public disclosure on property values led to a number of claims by homeowners.
 
 
10
 
The Company has entered into a number of individual settlements and has settled a class action lawsuit. Twenty-one of the individual settlements were made in the form of agreements with homeowners that obligated the Company to reimburse them for any estimated decline in the value of their homes at time of sale due to potential buyers’ concerns over contamination or, in the case of some agreements, to purchase the property after an agreed marketing period. Three of these agreements have had no claims made under them yet. The Company has also settled ten other property claims by homeowners who have sold their properties. In addition, the Company has settled Valice v. Cameron Iron Works, Inc. (80th Jud. Dist. Ct., Harris County, filed June 21, 2002), which was filed and settled as a class action. Pursuant to the settlement, the homeowners who remained part of the class are entitled to receive a cash payment of approximately 3% of the 2006 appraised value of their property or reimbursement of any diminution in value of their property due to contamination concerns at the time of any sale. To date, 49 homeowners have elected the cash payment.

Of the 258 properties included in the Valice class, there were 21 homeowners who opted out of the class settlement. There are three suits currently pending regarding this matter filed by non-settling homeowners. Moldovan v. Cameron Iron Works, Inc. (165th Jud. Dist. Ct., Harris County, filed October 23, 2006), was filed by six such homeowners. The other suits were filed by individual homeowners, Tuma v. Cameron Iron Works, Inc. (334th Judicial District Court of Harris County, Texas, filed on November 27, 2006), and Rudelson v. Cooper Industries, Inc. (189th Judicial District Court of Harris County, Texas, filed on November 29, 2006). The complaints filed in these actions make the claim that the contaminated underground water has reduced property values and seek recovery of alleged actual and exemplary damages for the loss of property value.

While one suit related to this matter involving health risks has been filed, the Company is of the opinion that there is no health risk to area residents and that the suit is without merit.

The Company believes, based on its review of the facts and law, that any potential exposure from existing agreements, the class action settlement or other actions that have been or may be filed, will not have a material adverse effect on its financial position or results of operations. The Company has reserved a total of $15,066,000 for these matters as of June 30, 2007.

The Company has been named as a defendant in a number of multi-defendant, multi-plaintiff tort lawsuits since 1995. At June 30, 2007, the Company’s consolidated balance sheet included a liability of approximately $3,484,000 for such cases, including estimated legal costs. The Company believes, based on its review of the facts and law, that the potential exposure from these suits will not have a material adverse effect on its financial condition or liquidity.

Regulatory Contingencies

In January 2007, the Company underwent a Pre-Assessment Survey as part of a Focused Assessment initiated by the Regulatory Audit Division of the U.S. Customs and Border Protection, Department of Homeland Security. The Pre-Assessment Survey resulted in a finding that the Company had deficiencies in its U.S. Customs compliance processes. The Company is taking corrective action and will undergo Assessment Compliance Testing in the first quarter of 2008. At June 30, 2007, the Company's consolidated balance sheet included a liability of $4,782,000 for the estimated additional customs duties which may be due.

Tax Contingencies

The Company has legal entities in over 35 countries. As a result, the Company is subject to various tax filing requirements in these countries. The Company prepares its tax filings in a manner which it believes is consistent with such filing requirements. However, some of the tax laws and regulations which the Company is subject to are subject to interpretation and/or judgment. Although the Company believes that the tax liabilities for periods ending on or before the balance sheet date have been adequately provided for in the financial statements, to the extent that a taxing authority believes that the Company has not prepared its tax filings in accordance with the authority’s interpretation of the tax laws/regulations, the Company could be exposed to additional taxes.

Note 13: Recently Issued Accounting Pronouncements

The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), on January 1, 2007. FIN 48 was issued in June 2006 in order to create a single model to address accounting for uncertainty in income tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold that a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods and disclosure.
 
11
 
As a result of the implementation of FIN 48, the Company recognized an increase of $13,888,000 in the liability for unrecognized tax benefits along with (i) a corresponding decrease of $4,996,000 in the January 1, 2007 balance of retained earnings, (ii) a decrease of $2,000,000 in capital in excess of par relating to amounts previously recognized in connection with the tax benefit of employee stock benefit plan transactions and, (iii) an increase in deferred tax assets of $6,892,000. This adjustment resulted in a total amount of unrecognized tax benefits at January 1, 2007 of $42,789,000.

The Company and its subsidiaries file income tax returns in the United States, various domestic states and localities and in many foreign jurisdictions. The earliest years’ tax returns filed by the Company that are still subject to examination by authorities in the major tax jurisdictions are as follows:

United States
United Kingdom
Canada
France
Germany
Norway
Singapore
2000
2001
1995
2004
2004
2003
1999
             
    
       Other than for the routine closure of statutory tax periods and review of valuation allowances, the Company is not currently aware of any adjustments that may occur that would materially increase or decrease the amount of its unrecognized tax benefits during the next twelve-month period.
 
The Company reflects interest related to an underpayment of income taxes as a component of interest expense in the Consolidated Results of Operations statement. Penalties on a tax position taken by the Company are reflected as a component of income tax expense in the Consolidated Results of Operations statement. There were no material accruals for unpaid interest or penalties upon adoption of FIN 48.

In February 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 provides entities with an option to measure many financial assets and liabilities and certain other items at fair value as determined on an instrument by instrument basis. The Company has not yet evaluated the impact, if any, this standard might have on the Company’s consolidated financial statements once it becomes effective on January 1, 2008.


12

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

In addition to the historical data contained herein, this document includes “forward-looking statements” regarding future market strength, order levels, revenues and earnings of the Company, as well as expectations regarding cash flows, future capital spending and the Company’s ability to issue additional debt or refinance its existing debt, made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company’s actual results may differ materially from those described in forward-looking statements. These statements are based on current expectations of the Company’s performance and are subject to a variety of factors, some of which are not under the control of the Company, which can affect the Company’s results of operations, liquidity or financial condition. Such factors may include overall demand for, and pricing of, the Company’s products; the size and timing of orders; the Company’s ability to successfully execute large subsea and drilling systems projects it has been awarded; the Company’s ability to convert backlog into revenues on a timely and profitable basis; the Company’s ability to successfully implement its capital expenditures program; the impact of acquisitions the Company has made or may make; changes in the price of (and demand for) oil and gas in both domestic and international markets; raw material costs and availability; political and social issues affecting the countries in which the Company does business; fluctuations in currency markets worldwide; and variations in global economic activity. In particular, current and projected oil and gas prices historically have generally affected customers’ spending levels and their related purchases of the Company’s products and services. Additionally, changes in oil and gas price expectations may impact the Company’s financial results due to changes in cost structure, staffing or spending levels. See additional factors discussed in “Factors That May Affect Financial Condition and Future Results” contained herein.

Because the information herein is based solely on data currently available, it is subject to change as a result of changes in conditions over which the Company has no control or influence, and should not therefore be viewed as assurance regarding the Company’s future performance. Additionally, the Company is not obligated to make public indication of such changes unless required under applicable disclosure rules and regulations.

SECOND QUARTER 2007 COMPARED TO SECOND QUARTER 2006

Consolidated Results - 

The Company’s net income for the second quarter of 2007 totaled $123.2 million, or $1.08 per diluted share, compared to $76.0 million, or $0.64 per diluted share, for the second quarter of 2006. The results for the second quarter of 2006 include (i) pre-tax charges of $9.1 million, or $0.05 per diluted share, for acquisition integration activities associated with the operations of the Flow Control segment of Dresser, Inc. that were acquired in late 2005 and early 2006 (the Dresser Acquired Businesses) and (ii) pre-tax foreign currency gains of $10.0 million, or $0.06 per diluted share, primarily relating to short-term intercompany loans made to the Company’s European subsidiaries in connection with the Dresser Acquired Businesses.

Revenues

Revenues for the second quarter of 2007 totaled $1.1 billion, an increase of $281.3 million, or 32.8%, from $857.8 million in the second quarter of 2006. Revenues increased in each business segment with the majority of the increase occurring in the DPS segment. A discussion of revenue by segment may be found below.

Costs and Expenses

Cost of sales (exclusive of depreciation and amortization) for the second quarter of 2007 totaled $792.1 million, an increase of 35.9% from $582.9 million in the second quarter of 2006. As a percentage of revenues, cost of sales increased from 68.0% in the second quarter of 2006 to 69.5% in the second quarter of 2007. The increase is primarily related to (i) the impact of the higher volume of large drilling projects on the second quarter of 2007 as compared to the second quarter of 2006, as these projects typically incur higher costs than the Company’s other day-to-day businesses (an approximate 2.0 percentage-point increase), (ii) an increase in accruals for U.S. import duties (a 0.4 percentage-point increase) and (iii) an accrual for the expected loss on a new technology project totaling approximately $4.7 million (a 0.4 percentage-point increase). These increases were partially offset by (i) an improvement in the cost of sales-to-revenue ratio in the distributed products, engineered valves and measurement product lines due largely to mix shifts within those lines (an approximate 0.8 percentage-point decrease) and (ii) the impact of the resolution of a royalty dispute during the second quarter of 2007, which resulted in additional royalty income of $4.8 million (a 0.3 percentage-point decrease).

Selling and administrative expenses increased $18.6 million, or 15.0%, from $124.6 million in the second quarter of 2006 to $143.2 million in the second quarter of 2007. The increase was largely attributable to additional costs related to higher headcount and
 
13
 
higher activity levels needed to support the expansion of the Company’s business as well as higher non-cash stock compensation expense totaling approximately $3.0 million.

Depreciation and amortization for the second quarter of 2007 totaled $27.1 million compared to $24.6 million for the second quarter of 2006, an increase of $2.5 million, or 10.3%. The increase is primarily due to increased capital spending levels in recent periods.

Interest income for the second quarter of 2007 totaled $6.3 million, an increase of $1.6 million from $4.7 million in the second quarter of 2006. The increase is mainly attributable to higher invested cash balances due primarily to positive cash flow from operations since the beginning of the second quarter of 2006 and the issuance of $500.0 million of convertible debt in May 2006.

Interest expense for the second quarter of 2007 totaled $6.0 million compared to $4.3 million in the second quarter of 2006, an increase of $1.7 million. Approximately $2.0 million of additional interest in the current-year quarter resulted from the issuance of $500.0 million of convertible debt in May 2006. This was partially offset by a $1.0 million reduction in the second quarter of 2007 as compared to the second quarter of 2006 relating to the repayment of $200.0 million of Senior Notes in April 2007. The remaining increase relates primarily to additional interest on certain tax contingencies and various international borrowings.

During the second quarter of 2006, acquisition integration costs totaling $9.1 million were incurred in connection with the integration of the Dresser Acquired Businesses, primarily into the operations of the V&M segment. Approximately $4.3 million of the costs related to non-cash asset impairment charges and $4.0 million related to employee severance at a legacy facility being closed as a result of the acquisition. The remaining costs were for plant rearrangement and other integration activities.

The income tax provision for the second quarter of 2007 was $53.6 million compared to $41.0 million for the second quarter of 2006. The effective tax rate for the second quarter of 2007 was 30.3% compared to 35.0% for the second quarter of 2006. The decrease in the effective rate is primarily attributable to a reduction of $6.5 million in the Company's tax provision for the second quarter of 2007, mainly resulting from a decrease in the valuation allowances previously established for certain deferred tax assets. The reduction in the Company’s valuation allowances was based on changes in facts which occurred during the quarter resulting in removal of the uncertainty surrounding the future utilization of certain international income tax deductions.

Segment Results - 

DPS Segment

 
Quarter Ended
June 30, 
Increase 
(dollars in millions)
2007 
2006 
$ 
% 
Revenues
$682
.9
$475
.7
$207
.2
43.6
%
Income before income taxes
$109
.3
$89
.1
$20
.2
22.6
%

Revenues of the DPS segment during the second quarter of 2007 totaled $682.9 million, an increase of $207.2 million, or 43.6%, compared to $475.7 million during the second quarter of 2006. Drilling sales increased 134.7%, surface sales were up 19.5% and sales of subsea equipment increased by 35.3%. These increases were partially offset by an 11.0% decline in sales of oil, gas and water separation applications. The increase in drilling sales primarily reflects the higher volume of large rig construction projects during the second quarter of 2007 and a higher level of aftermarket activity. Surface sales were up in all major regions of the world, except Canada. Nearly two-thirds of the increase in surface sales was for shipments to customers in the Eastern Hemisphere due largely to strong order rates which have existed over the last several quarters. Sales to customers in Canada were down as a result of a decline in Canadian activity levels as evidenced by a decrease in the rig count in that region. Sales of subsea equipment increased due primarily to shipments to major projects offshore West Africa during the second quarter of 2007. The decline in sales of oil, gas and water separation applications is primarily a result of timing associated with completion of milestones on projects.

Income before income taxes for the second quarter of 2007 totaled $109.3 million, an increase of $20.2 million, or 22.6%, from $89.1 million for the second quarter of 2006. Cost of sales as a percent of revenues increased from 68.1% for the second quarter of 2006 to 72.4% for the second quarter of 2007. The majority of the increase was attributable to (i) the impact of the higher volume of large drilling projects during the second quarter of 2007 as compared to the same period in the prior year, as these projects typically incur higher costs than the Company’s other day-to-day businesses (an approximate 3.4 percentage-point increase), (ii) changes in the ratio of costs to revenues for other product lines, driven mainly by the impact of higher-cost subsea projects as compared to the Company’s base subsea business, as well as cost increases and a mix shift during the current-year quarter toward higher shipments in North America of lower-pressure surface
 
 
14
 
equipment as compared to higher-pressure equipment, which carries more premium pricing (an approximate 0.6 percentage-point increase), (iii) an accrual for the expected loss on a new technology project totaling approximately $4.7 million (a 0.7 percentage-point increase) and (iv) an increase in U.S. import duties (a 0.4 percentage-point increase). This was partially offset by the impact of the resolution of a royalty dispute during the second quarter of 2007, which resulted in additional royalty income of $4.8 million (a 0.5 percentage-point decrease).

Selling and administrative expenses for the second quarter of 2007 totaled $65.6 million, an increase of $14.9 million, or 29.3%, as compared to $50.7 million for the second quarter of 2006. As a percentage of revenues, selling and administrative expenses declined from 10.7% in the second quarter of 2006 to 9.6% in the second quarter of 2007. The increase in selling and administrative expenses is due primarily to additional costs related to higher headcount and higher activity levels needed to support the expansion of the Company’s business.

Depreciation and amortization expense in DPS for the second quarter of 2007 was $13.8 million, an increase of $1.9 million, as compared to $11.9 million for the second quarter of 2006. The increase is due primarily to higher levels of capital spending in recent periods.

V&M Segment 

 
Quarter Ended
June 30, 
 
Increase 
(dollars in millions)
2007 
2006 
$ 
% 
Revenues
$315
.5
$271
.5
$44
.0
16.2
 %
Income before income taxes
$65
.1
$29
.5
$35
.6
120.5
 % 

Revenues of the V&M segment for the second quarter of 2007 totaled $315.5 million as compared to $271.5 million for the second quarter of 2006, an increase of $44.0 million, or 16.2%. Sales of distributed products were up 6.8% in the second quarter of 2007 versus the comparable period in 2006. Strong demand for distributed products in the United States more than offset a decline in demand from customers in Canada. Engineered product sales were up 14.7%, reflecting strong conditions in the pipeline market in recent periods which led to high shipment levels in the second quarter of 2007. Sales of process equipment increased 43.2% during the second quarter of 2007 as compared to the second quarter of 2006, driven largely by new liquefied natural gas (LNG) projects internationally, as well as refinery upgrades and new storage capacity projects. Measurement product line sales increased a modest 2.5% during the current year quarter compared to the same period in 2006.

Income before income taxes totaled $65.1 million for the second quarter of 2007, an increase of $35.6 million, or 120.5%, compared to $29.5 million for the second quarter of 2006. Cost of sales as a percent of revenues decreased from 68.9% for the second quarter of 2006 to 64.0% for the second quarter of 2007. The decrease was largely attributable to (i) improvement in the cost of sales-to-revenue ratio in the distributed, engineered valve and measurement product lines due largely to mix shifts within those lines (an approximate 2.8 percentage-point decrease), (ii) improvement in the ratio of cost of sales to revenues in the process valves product line due mainly to better pricing (an approximate 0.7 percentage-point decrease), (iii) the impact of relatively fixed indirect overhead costs, net of benefits obtained from certain recent facility consolidation and restructuring efforts, on a larger revenue base (a 1.6 percentage-point decrease) and (iv) foreign exchange gains in the second quarter of 2007 on liabilities denominated in non-functional currencies (a 0.3 percentage point decrease). This was partially offset by increased accruals for U.S. import duties (a 0.6 percentage-point increase).

Selling and administrative expenses increased by $3.7 million, or 9.8%, to $40.9 million in the second quarter of 2007 as compared to $37.2 million in the second quarter of 2006. Approximately $1.4 million of the increase was attributable to newly acquired entities since the beginning of the second quarter in 2006 with the remaining increase due largely to higher employee compensation and benefit costs.

Depreciation and amortization expense of the V&M segment decreased by $1.0 million in the second quarter of 2007 compared to the second quarter of 2006.

V&M incurred $9.0 million of acquisition integration costs in the second quarter of 2006 as a result of integrating the Dresser Acquired Businesses into the segment’s operations. These costs are described in more detail above.


15

CS Segment 

 
Quarter Ended
June 30,
 
Increase 
(dollars in millions)
2007 
2006 
$ 
% 
Revenues
$140
 .6
$110
 .6
$30
 .0
27.1
 %
Income before income taxes
$23
 .0
$12
 .8
$10
 .2
79.8
 %

Revenues of the CS segment for the second quarter of 2007 totaled $140.6 million, an increase of $30.0 million, or 27.1%, from $110.6 million for the second quarter of 2006. Gas compression sales increased 16.2% due largely to higher shipments of Ajax units to U.S.-based lease fleet operators and strong demand for aftermarket parts as a result of customers continuing to run their equipment at high utilization levels in the current year in order to take advantage of strong natural gas prices. In the air compression market, sales were up 47.3% due primarily to shipments of engineered machines designed to meet customers’ air separation needs.

Income before income taxes totaled $23.0 million for the second quarter of 2007, an increase of $10.2 million, or 79.8%, from $12.8 million in the comparable quarter of 2006. Cost of sales as a percent of revenues declined from 72.4% in the second quarter of 2006 to 69.2% in the second quarter of 2007. The improvement in the ratio is due primarily to (i) a lower level of costs in relation to revenues on the segment’s products mainly resulting from better pricing and the effect of international strategic sourcing efforts (a 1.5 percentage-point decrease) and (ii) the impact of relatively fixed indirect overhead costs in relation to a higher revenue base (a 2.5 percentage-point decrease). These improvements have been partially offset by certain favorable litigation settlements that occurred during the second quarter of 2006 that did not repeat during the second quarter of 2007 (a 1.0 percentage-point increase).

Selling and administrative expenses for the second quarter of 2007 totaled $17.1 million compared to $14.4 million for the second quarter of 2006, an increase of $2.7 million or 18.5%. The increase is primarily attributable to certain facility consolidation and realignment costs during the second quarter of 2007 as well as increased costs associated with higher headcount and higher activity levels.

Depreciation and amortization expense for the CS segment increased by $0.1 million to $3.3 million in the second quarter of 2007 from $3.2 million in the second quarter of 2006. The increase is due primarily to higher levels of capital spending, which has been partially offset by the impact of assets being sold or becoming fully depreciated in recent periods.

Corporate Segment 

The Corporate segment’s loss before income taxes totaled $20.6 million for the second quarter of 2007 as compared to $14.5 million for the second quarter of 2006, an increase of $6.1 million. Included in the loss for the second quarter of 2006 was a foreign currency gain of $8.2 million relating mainly to short-term intercompany loans made to the Company’s European subsidiaries in connection with the acquisition of the Dresser Acquired Businesses in late 2005. Results for the second quarter of 2007 included a foreign currency gain of $1.5 million, or $6.7 million less than the comparable amount in the prior year.

Partially offsetting the impact of the lower foreign currency gain was a decrease of $2.6 million in selling and administrative expenses in the second quarter of 2007 as compared to the second quarter of 2006, due largely to lower employee incentive costs of approximately $5.7 million, which have been partially offset by a $3.0 million increase in non-cash stock compensation expense for the current period.

Depreciation and amortization increased by $1.6 million in the second quarter of 2007 as compared to the second quarter of 2006 due mainly to differences in internal allocations between segments associated with the amortization of enterprise-wide information technology assets.

A discussion of changes in interest income and interest expense may be found in “Consolidated Results” above.


16

ORDERS

Orders were as follows (dollars in millions):

 
Quarter Ended
June 30, 
 
Increase 
 
2007 
2006 
$ 
% 
DPS
$828.6
 
$807.5
 
$21.1
 
2.6%
  
V&M
345.6
 
315.5
 
30.1
 
9.5%
  
CS
139.9
 
136.7
 
3.2
 
2.3%
  
 
$1,314.1
 
$1,259.7
 
$54.4
 
4.3%
  

Orders for the second quarter of 2007 increased $54.4 million, or 4.3%, from the second quarter of 2006.

Orders in the DPS segment for the second quarter of 2007 totaled $828.6 million, an increase of 2.6% from $807.5 million in the second quarter of 2006. Orders for subsea and surface products were up 129.3% and 6.5%, respectively. Subsea orders increased as a result of two large awards in the second quarter of 2007, and the increase in surface products was due primarily to higher order levels in all major regions of the world, except Canada, where activity levels have declined in the current year. Additionally, orders for oil, gas and water separation applications were up 113.2% as compared to the prior year due mainly to awards for large gas treatment projects in Norway and Brazil. These increases were offset by a 67.0% decline in orders for drilling products. The decrease in drilling orders resulted from the absence in the current year of large orders received in the second quarter of 2006 relating to major rig construction projects.

The V&M segment had orders of $345.6 million in the second quarter of 2007, an increase of 9.5% from $315.5 million in the comparable period of 2006. During the second quarter of 2007, orders for engineered products were up 32.4%. The increase in engineered orders primarily reflects continued strong demand for valves resulting from large pipeline construction projects. Process orders increased by 8.6% during the second quarter of 2007 as compared to the same period in 2006 due largely to refinery expansions and upgrades and new LNG process projects. These increases were partially offset by a 19.9% decline in orders for distributed products. This decline is due to weak Canadian markets and the absence in 2007 of the large stocking orders placed by U.S. distributors during the second quarter of 2006.

Orders in the CS segment for the second quarter of 2007 totaled $139.9 million, an increase of 2.3% from $136.7 million in the second quarter of 2006. Overall orders in the gas compression market were down 4.1% as compared to the prior year with orders for Ajax units down 52.9% due to a nonrecurring significant capital expansion project which was awarded in the same period of 2006. Orders for Superior compressors increased 15.6% due to demand for a newly designed compressor line and stronger demand in the United States. Overall orders for plant air products increased 36.3% due to strong demand for new equipment used primarily for air separation applications. Orders for engineered machines decreased 8.1% as demand was down slightly from the very strong order levels for these machines in the second quarter of 2006.

SIX MONTHS ENDED JUNE 30, 2007 COMPARED TO SIX MONTHS ENDED JUNE 30, 2006

Consolidated Results - 

The Company’s net income for the six months ended June 30, 2007 totaled $224.2 million, or $1.95 per diluted share, compared to $132.0 million, or $1.11 per diluted share, in the six months ended June 30, 2006. The results for the first half of 2006 include (i) pre-tax charges of $19.1 million, or $0.10 per diluted share, for acquisition integration costs associated with the Dresser Acquired Businesses that were purchased in late 2005 and early 2006, (ii) pre-tax foreign currency gains of $10.4 million, or $0.06 per diluted share, relating primarily to short-term intercompany loans made to the Company’s European subsidiaries in connection with the acquisition of the Dresser Acquired Businesses and (iii) a pre-tax charge of $6.5 million, or $0.04 per diluted share, for a class action lawsuit related to environmental contamination near a former manufacturing facility (see Note 12 of the Notes to Consolidated Condensed Financial Statements).

Revenues

Revenues for the six-month period ended June 30, 2007 totaled $2.1 billion, an increase of $448.7 million, or 26.6%, from $1.7 billion for the six-month period ended June 30, 2006. Revenues increased in each business segment with the majority of the increase occurring in the DPS segment. A discussion of revenues by segment may be found below.
 
17
 
Costs and Expenses

Cost of sales (exclusive of depreciation and amortization) for the first six months of 2007 totaled $1.5 billion, an increase of $318.1 million from $1.2 billion in the first six months of 2006. Cost of sales as a percent of revenues increased from 69.2% in the first six months of 2006 to 69.6% in the first six months of 2007. The majority of the increase was attributable to (i) the impact of the higher volume of large drilling projects during the six months ended June 30, 2007 as compared to the same period in the prior year, as these projects typically incur higher costs than the Company’s other day-to-day businesses (an approximate 1.6 percentage-point increase), and (ii) a decrease in the current period of $7.9 million in foreign currency gains mainly relating to the changing value of the U.S. dollar in relation to short-term intercompany loans the Company has with various foreign subsidiaries that are denominated in currencies other than the U.S. dollar (a 0.5 percentage-point increase). These increases are partially offset by (i) an improvement in the ratio of cost of sales to revenues in the distributed products and process valves products lines due largely to improved pricing (approximately a 0.5 percentage-point decrease), (ii) improvement in the cost of sales-to-revenue ratio in the engineered products and measurement product line resulting mainly from a mix shift in those product lines (approximately a 0.4 percentage-point decrease), (iii) improvement in the cost of sales to revenue ratio in the Compression Systems segment resulting primarily from improved pricing, the effect of international strategic sourcing efforts, greater absorption of factory overhead due to higher volumes and the impact of lower subcontract costs (a 0.3 percentage-point decrease) and (iv) the application of relatively fixed manufacturing overhead to a larger revenue base (approximately a 0.5 percentage-point decrease).

Selling and administrative expenses for the first six months of 2007 totaled $269.3 million, an increase of $19.0 million, or 7.6%, from $250.3 million for the first six months of 2006. Higher headcount levels and additional costs needed to support the expansion of the Company’s business were the primary factors for the increase in selling and administrative costs in the DPS, V&M and CS segments by $29.9 million. This increase was offset by a decline in selling and administrative expenses in the Corporate segment of $10.9 million. The decrease in selling and administrative expenses for the Corporate segment is mainly due to (i) a $5.8 million one-time reduction in pension expense recognized in the first six months of 2007 relating to one of the Company’s non-U.S. defined benefit pension plans and (ii) the absence in the first six months of 2007 of a $6.5 million charge taken in the first six months of 2006 for the estimated cost of settlement of a class action lawsuit related to environmental contamination near a former manufacturing facility.

Depreciation and amortization expense increased nearly $5.8 million, or 12.2%, to $53.0 million for the six months ended June 30, 2007 from $47.2 million for the six months ended June 30, 2006. The increase is due primarily to higher levels of capital spending in recent periods.

Interest income for the first six months of 2007 totaled $17.3 million, an increase of $9.5 million from $7.8 million for the first six months of 2006. The increase is primarily attributable to higher invested cash balances resulting from positive cash flow from operations since the beginning of 2006 and the issuance of $500 million of convertible debt in May 2006.

Interest expense for the six-month period ended June 30, 2007 totaled $12.8 million, an increase of $5.3 million from $7.5 million for the six-month period ended June 30, 2007. Approximately $5.1 million of the increase is due to the issuance of $500 million of convertible debt in May 2006.

During the first six months of 2006, acquisition integration costs totaling $19.1 million were incurred in connection with the integration of the Dresser Acquired Businesses, primarily into the operations of the V&M segment. Approximately $10.8 million of the costs related to non-cash asset impairment charges and $4.0 million related to employee severance at a legacy facility that was closed as a result of the acquisition. The remaining costs were for employee stay bonuses, employee relocation, plant rearrangement and other integration costs.

The income tax provision for six months ended June 30, 2007 was $108.0 million compared to $71.1 million for the six months ended June 30, 2006. The effective tax rate for the six months ended June 30, 2007 was 32.5% compared to 35.0% for the six months ended June 30, 2006. The decrease in the 2007 tax rate is primarily attributable to a reduction of $7.2 million in the Company's tax provision for the six months ended June 30, 2007, mainly resulting from a decrease in the valuation allowances previously established for certain deferred tax assets. The reduction in the Company’s valuation allowances was based on changes in estimates during the period regarding future utilization of certain international income tax deductions.


18

Segment Results - 

DPS Segment

 
Six Months Ended
June 30, 
 
Increase 
(dollars in millions)
2007 
2006 
$ 
% 
Revenues
$1,296
.6
$910
 .9
$385
 .7
42.3
 %
Income before income taxes
$212
 .7
$166
 .3
$46
 .4
28.0
 %

DPS segment revenues for the six months ended June 30, 2007 totaled $1.3 billion, an increase of 42.3% compared to $910.9 million during the six months ended June 30, 2006. Sales of drilling products increased 113.0%, surface sales were up 25.9%, subsea equipment sales increased 30.0% and sales of oil, gas and water separation applications were 15.0% higher than during the six months ended June 30, 2006. Over two-thirds of the increase in drilling sales relates to the higher volume of large rig construction projects with the remainder attributable mainly to higher land drilling activity. Surface sales were up in all major regions of the world, except Canada. Over 60% of the increase in surface sales is attributable to higher shipments to customers in the Eastern Hemisphere due largely to the strong order rates which have existed over the last several quarters. The decrease in Canadian sales reflects the lower rig count levels during the year in Canada due to a weakening in natural gas prices in the region. The increase in subsea equipment sales primarily reflects a higher level of shipments for major offshore projects in West Africa and Brazil as well as an increase in aftermarket activity. Revenues associated with an oil separation application to be used on a floating storage platform offshore Brazil accounted for the majority of the increase in the oil, gas and water separation line.

Income before income taxes for the first six months of 2007 totaled $212.7 million, an increase of 28.0%, from $166.3 million in the first six months of 2006. Cost of sales as a percent of revenues increased from 68.3% during the six months ended June 30, 2006 to 72.0% for the six-month period ended June 30, 2007. The majority of the increase was attributable to (i) the impact of the higher volume of large drilling projects during the six months ended June 30, 2007 as compared to the same period in the prior year, as these projects typically incur higher costs than the Company’s other day-to-day businesses (an approximate 2.7 percentage-point increase), (ii) an accrual for the expected loss on a new technology project totaling approximately $4.7 million (a 0.4 percentage-point increase), (iii) the effect of a settlement of a warranty issue reached in the first six months of 2006 that resulted in a reduction in warranty expense of $3.6 million during that period (a 0.4 percentage-point increase in the ratio for the first six months of 2007 as compared to the ratio for the first six months of 2006) and (iv) changes in the ratio of costs to revenues for other product lines, driven mainly by the impact of higher cost large subsea projects as compared to the Company’s base subsea business (a 0.5 percentage-point increase). This has been partially offset by the impact of the settlement of a royalty dispute during the six months ended June 30, 2007, which resulted in additional royalty income of $4.8 million (a 0.3 percentage point decrease).

Selling and administrative expenses for the first six months of 2007 totaled $123.6 million, an increase of $24.5 million, or 24.8%, as compared to $99.1 million for the first six months of 2006. As a percentage of revenues, selling and administrative expenses declined from 10.9% in the first six months of 2006 to 9.5% in the first six months of 2007. The increase in selling and administrative costs is due primarily to additional costs related to higher headcount and higher activity levels needed to support the expansion of the Company’s business.

Depreciation and amortization expense in DPS for the six months ended June 30, 2007 was $27.0 million, an increase of $3.9 million, or 16.7%, as compared to $23.1 million for the six months ended June 30, 2006. The increase is due primarily to higher levels of capital spending in recent periods.

V&M Segment

 
Six Months Ended
June 30, 
 
Increase 
(dollars in millions)
2007 
2006 
$ 
% 
Revenues
$611
.4
$570
.5
$40
.9
7.2
%
Income before income taxes
$126
.9
$55
.4
$71
.5
129.2
%

Revenues of the V&M segment for the six months ended June 30, 2007 totaled $611.4 million as compared to $570.5 million during the six months ended June 30, 2006, an increase of $40.9 million, or 7.2%. The revenue gain was driven largely by a 35.6% increase in sales of process equipment and a 4.5% increase in demand for distributed products. Sales of engineered products and measurement product line sales were relatively flat during the first six months of 2007 as compared to the same period in 2006. The increase in sales to customers in process markets reflects the impact of improvements in current year pricing as well as shipments
 
19
 
associated with strong order levels in late 2006, driven largely by new LNG projects internationally, refinery upgrades and new storage capacity projects. The increase in demand for distributed products largely reflects the strong order rate which existed in 2006 in the U.S. markets, which more than offset a decline in demand from the Canadian market.

Income before income taxes totaled $126.9 million for the first six months of 2007, an increase of 129.2%, from $55.4 million during the first six months of 2006. Cost of sales as a percent of revenues declined from 70.9% for the six-month period ended June 30, 2006 to 64.3% for the six-month period ended June 30, 2007. The decline is due largely to (i) improvement in the ratio of cost of sales to revenues in the distributed products and process valves products lines due largely to improved pricing (approximately a 1.9 percentage-point decrease), (ii) improvement in the cost of sales-to-revenue ratio in the engineered products and measurement product lines resulting mainly from a mix shift in those product lines (approximately a 2.2 percentage-point decrease), (iii) lower spending on certain variable costs (an approximate 0.5 percentage-point decrease) and (iv) the application of relatively fixed manufacturing overhead, net of benefits obtained from recent facility consolidation and restructuring efforts, to a larger revenue base (approximately a 1.8 percentage-point decrease).

Selling and administrative expenses for the six months ended June 30, 2007 totaled $76.6 million, an increase of nearly $1.0 million, or 1.2% from the comparable period in 2006. Included in selling and administrative expenses are approximately $2.3 million of costs associated with businesses acquired since June 30, 2006. This increase has been partially offset by actions taken in previous periods to consolidate production into certain locations following the acquisition of the Dresser Acquired Businesses.

Depreciation and amortization in the V&M segment decreased by $1.3 million from $16.1 million in the first six months of 2006 to $14.8 million in the same period of 2007, primarily as a result of internal allocations with the Corporate segment regarding amortization of enterprise-wide software applications.

V&M incurred $19.0 million of acquisition integration costs in the first six months of 2006 as a result of integrating the Dresser Acquired Businesses into the segment’s operations. These costs are described in more detail above.

CS Segment

 
Six Months Ended
June 30, 
 
Increase 
(dollars in millions)
2007 
2006 
$ 
% 
Revenues
$228
 .1
$206
 .0
$22
 .1
10.7
 %
Income before income taxes
$30
 .3
$22
 .5
$7
 .8
34.4
 %

CS segment revenues for the six months ended June 30, 2007 totaled $228.1 million, an increase of $22.1 million, or 10.7%, from $206.0 million for the six months ended June 30, 2006. Sales of gas compression equipment were up 8.0% in the first six months of 2007 while sales of air compression equipment increased 16.7% as compared to the first six months of 2006. New gas compression equipment sales were up 5.9% due largely to higher shipments of Ajax units resulting mainly from high year-end backlog levels, partially offset by a decline in the amount of shipments of Superior compressors to U.S.-based packagers. Aftermarket parts sales were up 10.3% as customers have continued to run equipment at high utilization levels in the current year in order to take advantage of strong natural gas prices. New air equipment sales were up 20.5% mainly reflecting strong demand for engineered machines designed to meet customers’ air separation needs.

Income before income taxes for the CS segment totaled $30.3 million for the first six months of 2007 compared to $22.5 million for the first six months of 2006, an increase of $7.8 million, or 34.4%. Cost of sales as a percent of revenues declined from 72.6% in the first six months of 2006 to 69.9% for the comparable period in 2007. The improvement in the ratio is due primarily to (i) a lower level of costs in relation to revenues on the segment’s products mainly resulting from better pricing and the effect of international strategic sourcing efforts (a 1.5 percentage-point decrease) and (ii) greater absorption of factory overhead due to higher volumes and the impact of lower subcontract costs (a 1.4 percentage-point decrease). These improvements have been partially offset by certain favorable litigation settlements which occurred during the first six months of 2006 that did not repeat during 2007 (a 0.2 percentage-point increase).

Selling and administrative expenses for the first six months of 2007 totaled $31.8 million, an increase of $4.4 million, or 16.3%, from $27.4 million during the comparable period of 2006. The increase was largely attributable to (i) plant consolidation and restructuring costs during the first six months of 2007 and (ii) additional costs related to higher headcount and higher activity levels to support the expansion of the Company’s business.
 
20
 
Depreciation and amortization for the six months ended June 30, 2007 totaled $6.6 million, an increase of $0.1 million, or 1.7%, mostly due to the higher level of capital spending in recent periods.

Corporate Segment

The Corporate segment’s loss before income taxes was $37.7 million in the first six months of 2007 as compared to $41.0 million in the first six months of 2006.

Included in the Corporate segment’s loss for the six months ended June 30, 2007 was a gain of $0.1 million relating to the changing value of the U.S. dollar in relation to short-term intercompany loans the Company has with various foreign subsidiaries that are denominated in currencies other than the U.S. dollar. For the six months ended June 30, 2006, a gain of $8.6 million was recognized in the Corporate segment relating to similar intercompany loans.

Selling and administrative expenses decreased by $10.9 million, or 22.6%, in the first six months of 2007 compared to the same period in 2006. The decrease is mainly due to (i) a $5.8 million one-time reduction in pension expense recognized in the first six months of 2007 relating to one of the Company’s non-U.S. defined benefit pension plans, (ii) the absence in the first six months of 2007 of a $6.5 million charge taken in the first six months of 2006 for the estimated cost of settlement of a class action lawsuit related to environmental contamination near a former manufacturing facility and (iii) lower employee incentive costs of approximately $5.4 million. This was partially offset by higher non-cash stock compensation costs totaling approximately $2.8 million and other increased spending for professional consulting services and for increased headcount.

Depreciation and amortization increased by $3.0 million primarily due to differences in internal allocations between segments associated with the amortization of enterprise-wide information technology assets.

The increases in interest income and interest expense during the first six months of 2007 as compared to the same period in 2006 are discussed in “Consolidated Results” above.

ORDERS & BACKLOG

Orders were as follows (dollars in millions):

 
Six Months Ended
June 30, 
 
Increase/(decrease) 
 
2007 
2006 
$ 
% 
DPS
$1,558
 .1
$1,654
 .3
$(96
 .2)
(5
 .8)%
V&M
700
 .3
675
 .9
24
 .4
3
 .6%
CS
307
 .0
264
 .7
42
 .3
16
 .0%
 
$2,565
 .4
$2,594
 .9
$(29
 .5)
(1
 .1)%

Orders for the first six months of 2007 were down $29.5 million, or 1.1%, from $2.6 billion for the first six months of 2006.

DPS segment orders for the first six months of 2007 totaled $1.6 billion, down 5.8% compared to $1.7 billion for the first six months of 2006. Orders for subsea and surface products were up 56.3% and 14.2%, respectively. Subsea orders were up from the prior year as a result of two large project awards, and the increase in surface products resulted mainly from a large order for repair services in Europe. Additionally, orders for oil, gas and water separation applications were up 72.2% as compared to the prior year due mainly to awards for large gas treatment projects in Norway and Brazil. These increases were offset by a 57.0% decline in orders for drilling products. The decrease in drilling orders reflects the absence of large orders in 2007 relating to rig construction activity that were awarded during the first half of 2006.

The V&M segment had orders of $700.3 million in the first half of 2007, an increase of 3.6% from $675.9 million in the comparable period of 2006. During the first six months of 2007, orders for engineered products were up 28.6%. The increase in engineered orders primarily reflects continued strong demand for valves resulting from large pipeline construction projects. This increase was partially offset by a decline in orders for distributed products and process valves of 24.8% and 7.9%, respectively. Distributed products declined due to weak Canadian markets and the absence in 2007 of the large stocking orders placed by U.S. distributors during the first six months of 2006. Orders for process valves also slowed as a result of project awards recorded during the first six months of 2006 which did not recur in 2007.
 
21
 
Orders in the CS segment for the first half of 2007 totaled $307.0 million, an increase of 16.0% from $264.7 million in the first half of 2006. Orders in the gas compression market were up 1.8% as compared to the prior year with orders for Ajax units down 26.4% due to slower capital investments by domestic lease fleet operators coupled with a product mix shift in orders from Russia. Orders for Superior compressors increased 17.4% due to demand for a newly designed compressor line and stronger demand from customers in the United States. Parts orders increased 13.2% as a result of strong international demand in Europe and Asia Pacific and strong natural gas prices. Orders for plant air increased 40.6% due to strong demand for new equipment used primarily for air separation applications. Orders for engineered machines were up 32.3% due to strong interest internationally for air separation and engineered air machines. Orders for parts increased 45.7% compared to the prior year mainly for legacy parts and units.

Backlog was as follows (dollars in millions):

 
June 30,
2007 
Dec. 31,
2006 
 
Increase 
DPS
$2,938
 .9
$2,661
 .3
$277
 .6
V&M
718
 .3
620
 .8
97
 .5
CS
323
 .2
248
 .9
74
 .3
 
$3,980
 .4
$3,531
 .0
$449
 .4

Liquidity and Capital Resources

The Company’s cash and cash equivalents decreased by $566.1 million to $467.4 million at June 30, 2007 as compared to $1.0 billion at December 31, 2006. The main reasons for the decrease were (i) the repayment in April 2007 of all of the outstanding $200.0 million 2.65% Senior Notes, (ii) the purchase of 4.7 million shares of treasury stock at a cost of $277.4 million, or $59.35 per share, (iii) the acquisition of certain assets and liabilities of four businesses during the first half of 2007 at a total cash cost of $75.7 million and (iv) capital expenditures of $108.0 million. These cash outflows were partially offset by $54.3 million of cash flow from operations during the first half of 2007 and $22.3 million of proceeds from stock option exercises.

During the first half of 2007, the Company generated $54.3 million of cash from operations as compared to $111.7 million for the same period in 2006. The primary reason for the decrease was due to the higher level of spending on working capital in 2007 in order to support the increased activity levels within the Company. Working capital increased $248.9 million for the first six months of 2007 as compared to a $123.5 million increase for the comparable period in 2006. Increased investment in inventory along with a $84.3 million decline in advances from customers were the biggest contributors to the change in working capital increases between the two periods.

The Company utilized $180.0 million of cash for investing activities during the first half of 2007 compared to $105.1 million during the same period in 2006. Approximately $108.0 million of cash was utilized for capital expenditures in the first half of 2007 compared to $73.7 million in the first half of 2006. The increase reflects the Company’s intentions to increase capacity, improve efficiency and address market needs by upgrading machine tools, facilities and manufacturing processes. Additionally, $75.7 million was utilized in the first half of 2007 in connection with the acquisitions of certain assets and liabilities of four businesses (see Note 2 of the Notes to Consolidated Condensed Financial Statements for additional information).

During the first half of 2007, the Company’s financing activities used $445.2 million of cash compared to cash generated of $284.8 million during the first half of 2006. The Company spent $277.4 million of cash in the first half of 2007 to acquire 4.7 million shares of treasury stock at an average cost of $59.35 per share. This compares to $237.7 million spent in the first six months of 2006 for 5.3 million shares of treasury stock. Additionally, the Company repaid all of its outstanding $200.0 million 2.65% Senior Notes in April 2007. In May 2006, the Company issued $500.0 million of 2.5% convertible debt.

The Company expects to incur an estimated $225.0 million to $250.0 million of capital expenditures during 2007 in connection with its program of improving manufacturing efficiency and expanding capacity. Cash on hand and current-year operating cash flow will be utilized to fund these expenditures for the remainder of 2007. In addition, the Company has begun a $63.5 million expansion of its manufacturing operations in Romania to expand the Company’s capacity for high-pressure, high-specification wellheads and trees for the surface equipment markets, particularly in Europe, Africa, Russia and the Mediterranean and Caspian Seas. The majority of this expenditure will occur in 2008.

On a longer-term basis, the Company has outstanding $238.0 million of 1.5% convertible debentures. Holders of these debentures could require the Company to redeem them beginning in May 2009. Holders of the Company’s 2.5% convertible debentures could also require the Company to redeem them beginning in June 2011. The Company believes, based on its current financial condition,
 
22
 
existing backlog levels and current expectations for future market conditions, that it will be able to meet its short- and longer-term liquidity needs through additional debt issuances or refinancing or with cash generated from operating activities, existing cash balances on hand and amounts available under its $350.0 million five-year multicurrency revolving credit facility, expiring October 12, 2010, subject to certain extension provisions.

Factors That May Affect Financial Condition and Future Results

The inability of the Company to deliver its backlog on time could affect the Company’s future sales and profitability and its relationships with its customers.

At June 30, 2007, the Company’s backlog was nearly $4.0 billion, a record level for the Company. The ability to meet customer delivery schedules for this backlog is dependent on a number of factors including, but not limited to, access to the raw materials required for production, an adequately trained and capable workforce, project engineering expertise for certain large projects, sufficient manufacturing plant capacity and appropriate planning and scheduling of manufacturing resources. Many of the contracts the Company enters into with its customers require long manufacturing lead times and contain penalty or incentive clauses relating to on-time delivery. A failure by the Company to deliver in accordance with customer expectations could subject the Company to financial penalties or loss of financial incentives and may result in damage to existing customer relationships. Additionally, the Company bases its earnings guidance to the financial markets on expectations regarding the timing of delivery of product currently in backlog. Failure to deliver backlog in accordance with expectations could negatively impact the Company’s financial performance and thus cause adverse changes in the market price of the Company’s outstanding common stock and other publicly-traded financial instruments.

The Company has embarked on a significant capital expansion program.

In the first six months of 2007, the Company’s capital expenditures increased by nearly $34.3 million from the first six months of 2006. For 2007, the Company expects full-year capital expenditures of approximately $225.0 million to $250.0 million to continue its program of upgrading its machine tools, manufacturing technologies, processes and facilities in order to improve its efficiency and address current and expected market demand for the Company’s products. To the extent this program causes disruptions in the Company’s plants, or the needed machine tools or facilities are not delivered and installed or in use as currently expected, the Company’s ability to deliver existing or future backlog may be negatively impacted. In addition, if the program does not result in the expected efficiencies, future profitability may be negatively impacted.

Execution of subsea systems projects exposes the Company to risks not present in its surface business.

This market is significantly different from the Company’s other markets since subsea systems projects are significantly larger in scope and complexity, in terms of both technical and logistical requirements. Subsea projects (i) typically involve long lead times, (ii) typically are larger in financial scope, (iii) typically require substantial engineering resources to meet the technical requirements of the project and (iv) often involve the application of existing technology to new environments and in some cases, new technology. These projects accounted for approximately 8.4% of total revenues for the six months ended June 30, 2007. To the extent the Company experiences difficulties in meeting the technical and/or delivery requirements of the projects, the Company’s earnings or liquidity could be negatively impacted. As of June 30, 2007, the Company had a subsea systems project backlog of approximately $526.6 million.

Increases in the cost of and the availability of metals used in the Company’s manufacturing processes could negatively impact the Company’s profitability.

Commodity prices for items such as nickel, molybdenum and heavy metal scrap that are used to make the steel alloys required for the Company’s products continue to increase. Certain of the Company’s suppliers have passed these increases on to the Company. The Company has implemented price increases intended to offset the impact of the increase in commodity prices. However, if customers do not accept these price increases, future profitability will be negatively impacted. In addition, the Company’s vendors have informed the Company that lead times for certain raw materials are being extended. To the extent such change negatively impacts the Company’s ability to meet delivery requirements of its customers, the financial performance of the Company may suffer.
 
23
 
Downturns in the oil and gas industry have had, and may in the future have, a negative effect on the Company’s sales and profitability.

Demand for most of the Company’s products and services, and therefore its revenues, depends to a large extent upon the level of capital expenditures related to oil and gas exploration, production, development, processing and transmission. Declines, as well as anticipated declines, in oil and gas prices could negatively affect the level of these activities, or could result in the cancellation, modification or rescheduling of existing orders. As an example, during the latter part of 2006 and continuing into 2007, the Company has seen activity levels in Canada decline, which has resulted in declining demand for the Company’s surface equipment and distributed product offerings in that market. The Company is typically protected against financial losses related to products and services it has provided prior to any cancellation. However, if the Company’s customers cancel existing purchase orders, future profitability could be negatively impacted. Factors that contribute to the volatility of oil and gas prices include the following:

•   demand for oil and gas, which is impacted by economic and political conditions and weather;

•   the ability of the Organization of Petroleum Exporting Countries (OPEC) to set and maintain production levels and pricing;

•   level of production from non-OPEC countries;

•   policies regarding exploration and development of oil and gas reserves;

•   the political environments of oil and gas producing regions, including the Middle East;

•   the depletion rates of gas wells in North America; and

•   advances in exploration and development technology.

Fluctuations in worldwide currency markets can impact the Company’s profitability.

The Company has established multiple “Centers of Excellence” facilities for manufacturing such products as subsea trees, subsea chokes, subsea production controls and BOPs. These production facilities are located in the United Kingdom and other European and Asian countries. To the extent the Company sells these products in U.S. dollars, the Company’s profitability is eroded when the U.S. dollar weakens against the British pound, the euro and certain Asian currencies, including the Singapore dollar.

In connection with the acquisition of the Dresser Acquired Businesses in late 2005 and early 2006, the Company entered into a number of short-term loans between certain wholly-owned subsidiaries to finance the acquisition cost and working capital needs of certain of Dresser’s international operations. Due to a significant weakening of the U.S. dollar in the second quarter of 2006, the Company recognized a significant currency gain relating to these euro-denominated loans made by a United States-based entity. The majority of these loans have now been repaid. Except for this impact in the second quarter of 2006, the Company’s gain or loss on foreign currency dominated transactions in other periods has not been material.

The Company’s worldwide operations expose it to instability and changes in economic and political conditions, foreign currency fluctuations, trade and investment regulations and other risks inherent to international business.

The economic risks of doing business on a worldwide basis include the following:

•   volatility in general economic, social and political conditions;

•   differing tax rates, tariffs, exchange controls or other similar restrictions;

•   changes in currency rates;

•   inability to repatriate income or capital;

•   reductions in the number or capacity of qualified personnel; and

•   seizure of equipment.
 
24
 
Cameron has manufacturing and service operations that are essential parts of its business in developing countries and economically and politically volatile areas in Africa, Latin America, Russia and other countries that were part of the Former Soviet Union, the Middle East, and Central and South East Asia. The Company also purchases a large portion of its raw materials and components from a relatively small number of foreign suppliers in developing countries. The ability of these suppliers to meet the Company’s demand could be adversely affected by the factors described above.

The Company is subject to trade regulations that expose the Company to potential liability.

Doing business on a worldwide basis also puts the Company and its operations at risk due to political risks and the need for compliance with the laws and regulations of many jurisdictions. These laws and regulations impose a range of restrictions and/or duties on importation and exportation, operations, trade practices, trade partners and investment decisions. From time to time, the Company receives inquiries regarding its compliance with such laws and regulations.

The Company received a voluntary request for information in September 2005 from the U.S. Securities and Exchange Commission regarding certain of the Company’s West African activities and has responded to this request. The Company believes it has complied with all applicable laws and regulations with respect to its activities in this region. Additionally, the U.S. Department of Treasury’s Office of Foreign Assets Control made an inquiry regarding U.S. involvement in a United Kingdom subsidiary’s commercial and financial activity relating to Iran in September 2004 and the U.S. Department of Commerce made an inquiry regarding sales by another United Kingdom subsidiary to Iran in February 2005. The Company responded to these two inquiries and has not received any additional requests related to these matters. The Company has restricted its non-U.S. subsidiaries and persons from doing any new business with countries the United States has classified as being state sponsors of terrorism, which include Iran, Syria, Sudan, North Korea and Cuba.

In July 2007, the Company was one of a number of companies who received a letter from the Criminal Division of the U.S. Department of Justice requesting information on their use of a freight forwarder. The Department of Justice is inquiring into whether certain of the services provided to the Company by the freight forwarder may have involved violations of the U.S. Foreign Corrupt Practices Act. The Company is providing the requested information and has engaged counsel to conduct an investigation into its dealings with the freight forwarder.

In January 2007, the Company underwent a Pre-Assessment Survey as part of a Focused Assessment initiated by the Regulatory Audit Division of the U.S. Customs and Border Protection, Department of Homeland Security. The Pre-Assessment Survey resulted in a finding that the Company had deficiencies in its U.S. Customs compliance processes. The Company is taking corrective action and will undergo Assessment Compliance Testing in the first quarter of 2008.

The Company is subject to environmental, health and safety laws and regulations that expose the Company to potential liability.

The Company’s operations are subject to a variety of national and state, provisional and local laws and regulations, including laws and regulations relating to the protection of the environment. The Company is required to invest financial and managerial resources to comply with these laws and expects to continue to do so in the future. To date, the cost of complying with governmental regulation has not been material, but the fact that such laws or regulations are frequently changed makes it impossible for the Company to predict the cost or impact of such laws and regulations on the Company’s future operations. The modification of existing laws or regulations or the adoption of new laws or regulations imposing more stringent environmental restrictions could adversely affect the Company.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company is currently exposed to market risk from changes in foreign currency rates and changes in interest rates. A discussion of the Company’s market risk exposure in financial instruments follows.

Foreign Currency Exchange Rates

As described more fully above under “Factors That May Affect Financial Condition and Future Results — Fluctuations in worldwide currency markets can impact the Company’s profitability”, the Company has short-term intercompany loans and intercompany balances outstanding at June 30, 2007 denominated in currencies different from the functional currency of at least one of the parties. These transactions subject the Company’s financial results to risk from changes in foreign currency exchange rates. Other than the second quarter of 2006, these amounts had not resulted in recognition of a material foreign currency gain or loss due to fluctuations in the applicable exchange rates.
 
25
 
A large portion of the Company’s operations consist of manufacturing and sales activities in foreign jurisdictions, principally in Europe, Canada, West Africa, the Middle East, Latin America and the Pacific Rim. As a result, the Company’s financial performance may be affected by changes in foreign currency exchange rates or weak economic conditions in these markets. Overall, for those locations where the Company is a net receiver of local non-U.S. dollar currencies, Cameron generally benefits from a weaker U.S. dollar with respect to those currencies. Alternatively, for those locations where the Company is a net payer of local non-U.S. dollar currencies, a weaker U.S. dollar with respect to those currencies will generally have an adverse impact on the Company’s financial results. For each of the last three years, the Company’s gain or loss from foreign currency-denominated transactions has not been material, except as noted above.

In order to mitigate the effect of exchange rate changes, the Company will often attempt to structure sales contracts to provide for collections from customers in the currency in which the Company incurs its manufacturing costs. In certain instances, the Company will enter into forward foreign currency exchange contracts to hedge specific large anticipated receipts in currencies for which the Company does not traditionally have fully offsetting local currency expenditures. The Company was party to a number of long-term foreign currency forward contracts at June 30, 2007. The purpose of the majority of these contracts was to hedge large anticipated non-functional currency cash flows on major subsea, valve or drilling contracts involving the Company’s United States operations and its wholly-owned subsidiaries in Ireland, Italy, Singapore and the United Kingdom. Information relating to the contracts and the fair value recorded in the Company’s Consolidated Balance Sheet at June 30, 2007 follows:

 
Year of Contract Expiration 
  
(amounts in millions except exchange rates)
2007 
  
2008 
  
2009 
  
Total 
  
Buy GBP/Sell USD:
                
Notional amount to sell (in U.S. dollars)
$19.2
 
$11.0
 
$2.6
 
$32.8
  
Average GBP to USD contract rate
1.8075
 
1.8039
 
1.7989
 
1.8056
  
Average GBP to USD forward rate at June 30, 2007
2.0059
 
1.9931
 
1.9760
 
1.9992
  
                 
Fair value at June 30, 2007 in U.S. dollars
            
$3.5
  
                 
Sell GBP/Buy Euro:
                
Notional amount to buy (in euros)
4.3
 
0.9
 
—
 
5.2
  
Average GBP to EUR contract rate
1.3817
 
1.3693
 
—
 
1.3794
  
Average GBP to EUR forward rate at June 30, 2007
1.4771
 
1.4640
 
—
 
1.4747
  
                 
Fair value at June 30, 2007 in U.S. dollars
            
$(0.5
 ) 
                 
Sell GBP/Buy NOK:
                
Notional amount to buy (in Norwegian krone)
5.4
 
0.6
 
—
 
6.0
  
Average GBP to NOK contract rate
11.2645
 
11.2173
 
—
 
11.2598
  
Average GBP to NOK forward rate at June 30, 2007
11.8099
 
11.7652
 
—
 
11.8054
  
                 
Fair value at June 30, 2007 in U.S. dollars
            
$—
  
                 
Buy Euro/Sell USD:
                
Notional amount to buy (in euros)
34.9
 
33.0
 
0.9
 
68.8
  
Average EUR to USD contract rate
1.3282
 
1.3338
 
1.3276
 
1.3309
  
Average EUR to USD forward rate at June 30, 2007
1.3589
 
1.3641
 
1.3699
 
1.3615
  
                 
Fair value at June 30, 2007 in U.S. dollars
            
$2.1
  

Interest Rates

The Company is subject to interest rate risk on its long-term fixed interest rate debt and, to a lesser extent, variable-interest rate borrowings. Variable-rate debt, where the interest rate fluctuates periodically, exposes the Company’s cash flows to variability due to changes in market interest rates. Fixed-rate debt, where the interest rate is fixed over the life of the instrument, exposes the Company to changes in the fair value of its debt due to changes in market interest rates and to the risk that the Company may need to refinance maturing debt with new debt at a higher rate.
 
26
 
The Company manages its debt portfolio to achieve an overall desired position of fixed and floating rates and may employ interest rate swaps as a tool to achieve that goal. The major risks from interest rate derivatives include changes in the interest rates affecting the fair value of such instruments, potential increases in interest expense due to market increases in floating interest rates and the creditworthiness of the counterparties in such transactions.

The fair values of the 1.5% and 2.5% convertible senior debentures are principally dependent on both prevailing interest rates and the Company’s current share price as it relates to the initial conversion price of the respective instruments.

The Company has various other long-term debt instruments, but believes that the impact of changes in interest rates in the near term will not be material to these instruments.

Item 4. Controls and Procedures

In accordance with Exchange Act Rules 13a-15 and 15d-15, the Company carried out an evaluation, under the supervision and with the participation of the Company’s Disclosure Committee and the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2007 to ensure that information required to be disclosed by the Company that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. There were no material changes in the Company’s internal control over financial reporting during the period ended June 30, 2007.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

The Company is subject to a number of contingencies, including environmental matters, litigation, regulatory and tax contingencies.

Environmental Matters

The Company’s worldwide operations are subject to regulations with regard to air, soil and water quality as well as other environmental matters. The Company, through its environmental management system and active third-party audit program, believes it is in substantial compliance with these regulations.

The Company is currently identified as a potentially responsible party (PRP) with respect to two sites designated for cleanup under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) or similar state laws. One of these sites is Osborne, Pennsylvania (a landfill into which a predecessor of the CS operation in Grove City, Pennsylvania deposited waste), where remediation is complete and remaining costs relate to ongoing ground water treatment and monitoring. The other is believed to be a de minimis exposure. The Company is also engaged in site cleanup under the Voluntary Cleanup Plan of the Texas Commission on Environmental Quality at former manufacturing locations in Houston and Missouri City, Texas. Additionally, the Company has ceased operations at a number of other sites which had been active for many years. The Company does not believe, based upon information currently available, that there are any material environmental liabilities existing at these locations. At June 30, 2007, the Company’s consolidated balance sheet included a noncurrent liability of $6.3 million for environmental matters.

Legal Matters

In 2001, the Company discovered that contaminated underground water from the former manufacturing site in Houston referenced above had migrated under an adjacent residential area. Pursuant to applicable state regulations, the Company notified the affected homeowners. Concerns over the impact of the underground water contamination and its public disclosure on property values led to a number of claims by homeowners.

The Company has entered into a number of individual settlements and has settled a class action lawsuit.  Twenty-one of the individual settlements were made in the form of agreements with homeowners that obligated the Company to reimburse them for any
 
27
 
estimated decline in the value of their homes at time of sale due to potential buyers’ concerns over contamination or, in the case of some agreements, to purchase the property after an agreed marketing period. Three of these agreements have had no claims made under them yet. The Company has also settled ten other property claims by homeowners who have sold their properties. In addition, the Company has settled Valice v. Cameron Iron Works, Inc. (80th Jud. Dist. Ct., Harris County, filed June 21, 2002), which was filed and settled as a class action. Pursuant to the settlement, the homeowners who remained part of the class are entitled to receive a cash payment of approximately 3% of the 2006 appraised value of their property or reimbursement of any diminution in value of their property due to contamination concerns at the time of any sale. To date, 49 homeowners have elected the cash payment.

Of the 258 properties included in the Valice class, there were 21 homeowners who opted out of the class settlement. There are three suits currently pending regarding this matter filed by non-settling homeowners. Moldovan v. Cameron Iron Works, Inc. (165th Jud. Dist. Ct., Harris County, filed October 23, 2006), was filed by six such homeowners. The other suits were filed by individual homeowners, Tuma v. Cameron Iron Works, Inc. (334th Judicial District Court of Harris County, Texas, filed on November 27, 2006), and Rudelson v. Cooper Industries, Inc. (189th Judicial District Court of Harris County, Texas, filed on November 29, 2006).  The complaints filed in these actions make the claim that the contaminated underground water has reduced property values and seek recovery of alleged actual and exemplary damages for the loss of property value.

While one suit related to this matter involving health risks has been filed, the Company is of the opinion that there is no health risk to area residents and that the suit is without merit.

The Company believes, based on its review of the facts and law, that any potential exposure from existing agreements, the class action settlement or other actions that have been or may be filed will not have a material adverse effect on its financial position or results of operations. The Company has reserved a total of $15.1 million for these matters as of June 30, 2007.


The Company has been named as a defendant in a number of multi-defendant, multi-plaintiff tort lawsuits since 1995. At June 30, 2007, the Company’s consolidated balance sheet included a liability of approximately $3.5 million for such cases, including estimated legal costs. The Company believes, based on its review of the facts and law, that the potential exposure from these suits will not have a material adverse effect on its financial condition or liquidity.

Regulatory Contingencies

In January 2007, the Company underwent a Pre-Assessment Survey as part of a Focused Assessment initiated by the Regulatory Audit Division of the U.S. Customs and Border Protection, Department of Homeland Security. The Pre-Assessment Survey resulted in a finding that the Company had deficiencies in its U.S. Customs compliance processes. The Company is taking corrective action and will undergo Assessment Compliance Testing in the first quarter of 2008. At June 30, 2007, the Company's consolidated balance sheet included a liability of $4.8 million for the estimated additional customs duties which may be due.

Tax Contingencies

The Company has legal entities in over 35 countries. As a result, the Company is subject to various tax filing requirements in these countries. The Company prepares its tax filings in a manner which it believes is consistent with such filing requirements. However, some of the tax laws and regulations which the Company is subject to are subject to interpretation and/or judgment. Although the Company believes that the tax liabilities for periods ending on or before the balance sheet date have been adequately provided for in the financial statements, to the extent that a taxing authority believes that the Company has not prepared its tax filings in accordance with the authority’s interpretation of the tax laws/regulations, the Company could be exposed to additional taxes.

Item 1A. Risk Factors 

The information set forth under the caption “Factors That May Affect Financial Condition and Future Results” on pages 23 - 25 of this quarterly report on Form 10-Q is incorporated herein by reference.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

In February 2006, the Company’s Board of Directors changed the number of shares of the Company’s common stock authorized for repurchase from the 5,000,000 shares authorized in August 2004 to 10,000,000 shares in order to reflect the 2-for-1 stock split effective December 15, 2005. Additionally, on May 22, 2006, the Company’s Board of Directors approved repurchasing shares of the
 
28
 
Company’s common stock with the proceeds remaining from the Company’s 2.5% Convertible Debenture offering, after taking into account the repayment of $200.0 million principal amount of the Company’s outstanding 2.65% Senior Notes due 2007. This authorization is in addition to the 10,000,000 shares described above.

Purchases pursuant to the 10,000,000-share Board authorization may be made by way of open market purchases, directly or indirectly, for the Company’s own account or through commercial banks or financial institutions and by the use of derivatives such as a sale or put on the Company’s common stock or by forward or economically equivalent transactions. Shares of common stock purchased and placed in treasury during the three months ended June 30, 2007 under the Board’s two authorization programs described above are as follows:

 
 
 
 
 
 
 
Period
 
 
 
 
 
Total number
of shares
purchased 
 
 
 
 
 
 
Average price
paid per share 
 
 
Total number
of shares
purchased as
part of all
repurchase
programs (a) 
Maximum
number of
shares that may
yet be
purchased
under all
repurchase
programs (b) 
4/1/07 - 4/30/07
100,000
  
$66.43
  
10,770,471
  
4,959,172
  
5/1/07 - 5/31/07
1,762,400
  
$67.97
  
12,532,871
  
3,057,250
  
6/1/07 - 6/30/07
—
  
$—
  
12,532,871
  
3,045,900
  
Total
1,862,400
  
$67.89
  
12,532,871
  
3,045,900
  
____________

(a) All share purchases during the three months ended June 30, 2007 were done through open market transactions.

(b) At June 30, 2007, 1,411,856 shares are yet to be purchased under the $250,000,000 Board authorization, based on the closing price of the Company’s common stock at that date of $71.47 per share.

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

The Annual Meeting of Stockholders of the Company was held in Houston, Texas on May 9, 2007 for the purpose of (1) electing two Directors and (2) ratifying the appointment of independent registered public accountants for 2007. Proxies for the meeting were solicited pursuant to Regulation 14 of the Securities Exchange Act of 1934 and there was no solicitation in opposition to management’s solicitation. Results of the stockholder voting were as follows:

 
Number of Shares 
 
For 
Against 
Abstaining /
Withheld 
Broker
Non-Votes 
Election of Directors:
                
Michael E. Patrick
98,691,871
  
—
  
3,703,767
  
—
  
Bruce W. Wilkinson
100,751,304
  
—
  
1,644,334
  
—
  
Ratify the appointment of independent registered public accountants for 2007
98,882,041
  
3,454,315
  
59,282
  
—
  

Item 5. Other Information

(a)  
Information Not Previously Reported in a Report on Form 8-K

None
 
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(b)  
Material Changes to the Procedures by Which Security Holders May Recommend Board Nominees.

There have been no material changes to the procedures enumerated in the Company’s definitive proxy statement filed on Schedule 14A with the Securities and Exchange Commission on March 21, 2007 with respect to the procedures by which security holders may recommend nominees to the Company’s Board of Directors.

Item 6. Exhibits

Exhibit 31.1 -

Certification

Exhibit 31.2 -

Certification

Exhibit 32.1 -
 
Certification of the CEO and CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


30

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: August 1, 2007
Cameron International Corporation
 
(Registrant)
 
 
 
/s/ Franklin Myers
 
Franklin Myers
 
Senior Vice President and Chief Financial Officer and authorized to sign on behalf of the Registrant

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EXHIBIT INDEX
Exhibit
Number
Description
31.1
 
 
31.2
 
 
32.1
 

 
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