Welcome to the Flowserve 2018 Second Quarter Earnings Call. My name is Paulette, and I will be your operator for today's call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. Please note this conference is being recorded.
I will now turn the call over to Jay Roueche, Vice President of Investor Relations and Treasurer. You may begin.
Thank you, Paulette, and good morning, everyone. We appreciate you participating in our call today to discuss Flowserve's Q2 2018 financial results. Joining me this morning are Scott Rowe, Flowserve's President and Chief Executive Officer and Lee Eckard, Senior Vice President and Chief Financial Officer. Following our prepared comments, we will open the call for your questions. As a reminder, this event is being webcast, and an audio replay will be available.
Please note that our earnings to our reported results prepared in accordance with generally accepted accounting principles is available in both our press release and earnings presentation. Finally, this call and our associated earnings materials contain forward looking statements. These statements are based upon forecasts, expectations and other information available to management as of August 9, 2018, and they involve risks and uncertainties, many of which are beyond the company's control. And except to the extent required by applicable law, Flowserve undertakes no obligation and disclaims any duty to update any of these forward looking statements. We encourage you to fully review our Safe Harbor disclosures contained in yesterday's earnings materials, which are all available on our website at flowserv.com in the Investor Relations section.
I would now like to turn the call over to Scott Rowe, Flowserve's President and Chief Executive Officer, for his prepared comments.
Great. Thanks, Jay, and good morning, everyone. Thank you for joining today's call. During the quarter, Flowserve delivered solid financial results and continued to make progress on our transformational initiatives. Each of our segments delivered on their plans for the quarter and together we modestly exceeded our overall expectations.
We have more work ahead of us, but I am pleased with the results so far and the positive momentum that we have created. Yesterday, we reaffirmed our 2018 financial guidance, which we continue to view as realistic given where we are in the transformational journey. As I indicated when we first provided our targets in February, our internal aspirations are higher and that remains true today. But we first need to reinstill a culture of excellence, continuous improvement and focus on consistently meeting our commitments. We have made significant progress in this endeavor, but there is more work to be done.
Nevertheless, each month I gain confidence in our ability to execute and deliver results for our customers and our shareholders. I'll begin with some overall comments before going into the specifics. 1st, Flowserve continues to capture opportunities from improvements in our end markets. We are pleased that our overall book to bill ratio remained over 1.0 for the quarter the year, highlighted by strong aftermarket bookings in the quarter. Our sales growth of nearly 11%, combined with 110 basis points of higher adjusted operating margin produced adjusted earnings per share of $0.41 Additionally, we are aggressively pursuing our transformational strategy to drive operational excellence, reduce complexity, accelerate growth and streamline Flowserve's operating model.
The company also recently agreed to a planned divestiture of certain non strategic product lines in IPD, which we will close in the Q3. Turning now to the specifics. For the first time since the Q3 of 2015, we produced bookings over $1,000,000,000 in a quarter. The awarded work is broad based and represents a 6.8% increase year over year. Oil and Gas, Chemical and General Industry Markets all contributed growth over 10%.
An approximate 2% currency tailwind was partially offset by the 2017 divestiture impact totaling 1%. In the Q2, our largest project award was in the European water markets for approximately $25,000,000 which was recorded in general industries for a flood control project. The majority of our bookings growth is coming from smaller projects in the $3,000,000 to $5,000,000 range, which is more base or foundational business. With improved project visibility and an active quoting funnel, we are optimistic about the near term environment and believe we can deliver year over year bookings growth for the remainder of 2018. As you may recall from the Q1, we highlighted some of our efforts to increase price, not only to cover the cost pressures, but also to start recovering from the challenging environment over the last few years.
We continue to utilize price as a tool in selective markets and products and we'll do so in the future in a more analytical fashion as we remain committed to building and maintaining a quality backlog. We believe that these price increases have more than offset the effects of inflation and trade tariffs. As such, we see higher margins in our backlog today than at the beginning of the year. However, the global trade environment remains highly unpredictable. We will continue to monitor the market conditions and move forward with our strategy to localize our manufacturing, enhance our supplier network and increase price opportunistically.
While Flowserve's aftermarket franchise proved largely resilient throughout the cycle, we expected to see an uptick in customer spending this year. In the Q2, we delivered aftermarket bookings of $504,000,000 the highest level since 2014 and up 10% year over year. Our discussions with downstream and petrochemical customers suggest they are focused on maintaining productivity and higher levels of production within their facilities. The increased demand is showing up in our parts, services and small brownfield expansion opportunities. We believe our aftermarket franchise with its global network of quick response centers is a true competitive advantage and differentiator for Flowserve.
Looking now at the 2nd quarter bookings by served end markets and starting with our largest market, oil and gas. Bookings increased 12% year over year, including growth in all segments, supported by an improved and stable commodity price and increased customer spending in the downstream markets. EPD's bookings increased approximately 5%, including a $10,000,000 refining award in North America, while FCD and IPD saw a number of run rate awards across regions. We continue to expect increased investment by our customers based on a strong pipeline of pre FEED and FEED activities and projects progressing forward progressing towards FID before the end of the year. Downstream projects in the Middle East and Asia Pacific appear to be the most active.
In Chemical, our bookings increased approximately 13%, again with all segments delivering growth. EPD led the group with a 20 3% year over year improvement, which include a $13,000,000 award in North America. IPD and FCD contributed single digit bookings growth. We remain encouraged by the expected growth in chemical investment, both near and longer term as chemical demand is forecasted to grow globally. Plans for ethylene investment in Asia, the Middle East and North America continue to progress, including a number of projects currently in the backlog of EPCs.
Flowserve's power bookings decreased 7% year over year and remains our most challenged market. While IPD delivered strong 43% bookings growth, including 2 concentrated solar power project awards where we have a differentiated technical offering, we continue to have muted expectations in the power markets near term, as nuclear and traditional power generation have remained more challenged globally. General industry bookings increased 15%, driven again by strength in all segments, including 27% 12% growth in EPD and FCD, respectively, while IPD increased mid single digits. The efforts in the distribution channel delivered strength from the Americas, European and Middle Eastern regions, while Mining and Minerals is a relatively small percentage of our business, mining activity contributed across all segments. Geographically, North America and Europe grew 17% 26%, respectively, and Latin America provided 56% growth off a very low comparable base.
While Latin America remains challenged, we are pleased with consecutive quarterly growth in the region, which is up 29% year to date. The Middle East and Africa region and Asia Pacific were down in the quarter with each facing relatively strong prior year comparisons, but we remain optimistic in these regions as infrastructure growth persists. Turning now to our 2nd quarter performance by segment. IPD returned to profitability on an adjusted basis as it turned as its turnaround showed modest operational progress in the Q2. We expect to gain further traction and deliver improving financial results in the second half of the year.
In the quarter, IPD delivered revenue growth of 7.2% over prior year, which helped drive sequential and year over year improvements in adjusted operating margins. Operationally, IPD lowered its past due backlog in the quarter, which impacts margins due to low quality shipments. Reducing past due backlog in the near term, however, remains a critical component to achieving our mid to upper single digit operating margin target in the 4th quarter. I fully believe the operating performance improvements we are driving provide necessary accountability and visibility to reach this interim target, but more importantly to help position IPD to reach its full potential and mid teens margin business over the longer term. As I mentioned earlier, we are in the process of divesting 2 locations and the associated non core product lines in IPD that have not been profitable for the last couple of years.
This divestiture will enable the IPT team the IPD team to focus on growth and restoring profitability in their core markets and products. EPD delivered over 12% revenue growth in the quarter compared to the prior year on strong original equipment and aftermarket shipments, driving improvement in adjusted gross and operating margins of 110 and 170 basis points respectively. Actions continued in the quarter to realign EPD's manufacturing footprint to more effectively leverage and utilize our engineered capabilities and manufacturing network. FCD also drove margin improvement on solid revenue growth of 11.3%, including a roughly 2% headwind related to last year's divestitures. Adjusted growth and operating margins increased 10 and 170 basis points, respectively, year over year.
FCD expanded margins sequentially through better product mix, strong cost control and improved pricing. Our valves business has consistently delivered solid operating performance and we anticipate that full year 2018 will be no exception. Returning to the Flowserve level. We continue to believe the cycle has reversed course after a multiyear downturn and we are optimistic that our markets will continue to strengthen. From a project perspective, the global pipeline continues to grow and as visibility increases, we expect to remain disciplined and selective to ensure our backlog quality.
Additionally, we believe the transformational activities we are taking across the enterprise will position Flowserve to better serve our customers, accelerate growth and drive value for our shareholders. I'll now turn it over to Lee to discuss our financial results in greater detail, and then I'll turn for a few closing comments before we open the call to Q and A. Lee?
Thank you, Scott, and good morning, everyone. For the 2nd quarter, delivered adjusted earnings per share of $0.41 modestly above our expectations coming into the quarter. The change in revenue recognition accounting standards as we discussed in-depth last quarter added $0.07 versus accounting under the prior method. As a reminder, the new accounting standard required adoption on January 1 this year. The impact of Flowserve between the two approaches is primarily an increase in projects now counted for under a percentage of completion method.
We believe the margin difference between the two standards confirms the improved profitability we've received on recent orders versus orders in the backlog at the beginning of the year. On a reported EPS basis, we earned $0.10 per share, which includes the adjusted items comprised of $0.13 related to the planned divestiture of non strategic product lines and IPD that Scott discussed. Realignment expense of $0.12 and the remainder coming from below the line FX transformation and ASC 606 implementation. 2nd quarter sales increased 10.9% versus prior year to $973,000,000 We incurred a roughly 1% headwind as a result of businesses divested in 2017, which was more than offset by organic growth as well as currency tailwinds and a modest benefit from the new accounting standard. Aftermarket sales increased 12 0.4% year over year to $488,000,000 representing 50% of our total revenue for the quarter.
Original equipment sales increased 9.5% as compared to the 2017 Q2. Turning to gross margins. Our adjusted gross margin of 31.9% was up 40 basis points versus the prior year Q2. The margin increase is primarily due to volume leverage, cost actions and the impacts of profits related to the additional revenue recognized as a result of ASC 606. On a reported basis, our gross margin increased 140 basis points to 29.4% on volume leverage, cost savings, ASC 606 and lower adjusting item charges versus prior year.
Adjusted SG and A as a percentage of sales declined 90 basis points to 22.7%, including improvement in all segments. The decrease was driven by increased sales leverage and tight cost control more than offsetting increased incentive comp accruals and the impact from the weakened dollar. Adjusted operating margin increased 110 basis points to 9.3% in the 2nd quarter and included a modest 30 basis point improvement in IPD, while EPD and FCD's adjusted operating margins both increased 170 basis points. Our reported effective tax rate was elevated in the 2nd quarter, primarily related to a product line divestiture impairment where no tax benefit was realized on the charge. On an adjusted basis, the effective tax rate for the quarter was 26.1%.
Turning to cash. We generated $64,000,000 of operating cash flow in the 2nd quarter, an increase of 50% over the 2017 Q2. Our free cash flow in the quarter was $46,000,000 up over 50% from the prior year. We continue to maintain a strong cash balance at over $500,000,000 as of June 30. Capital expenditures in the quarter were $18,000,000 up about $5,000,000 from a year ago and we also returned $25,000,000 to shareholders through dividends.
Working capital was a use of approximately $25,000,000 in the quarter, clearly not where it needs to be and remains a primary area of focus. We are making progress in our initiatives directed to all aspects of both the order to cash and the sales and operating planning processes. Much work remains, but we do expect to realize benefits in the second half of the year. Turning to our 2018 outlook. With our first half results roughly in line with our expectations, we remain on pace for our full year and reaffirm our guidance, including the adjusted EPS target range of $1.50 to $1.70 per share.
We also confirmed our expected revenue growth of 3% to 6%, including a 2% full year currency benefit and roughly a 1% negative headwind from last year's business divestitures. The adjusted EPS target range excludes the 2018 expected realignment and transformation expense of approximately $90,000,000 as well as below the line foreign currency effects and the impact of potential other discrete items, which may occur during the year. Net interest expense is expected to be in the range of $58,000,000 to $60,000,000 and we continue to expect our adjusted tax rate to be in the 27% to 28% range. From a cash perspective, we expect to spend approximately $100,000,000 in 2018 to pay dividends to our shareholders. Capital expenditures are expected in the $80,000,000 to $90,000,000 range as we invest in technology to support Flowserve 2.0 and improve manufacturing productivity.
We also expect approximately $60,000,000 in debt repayment for the year and to contribute approximately $30,000,000 to our global pension plans, mainly to cover our ongoing service costs as the U. S. Plan remains largely fully funded. Now let me turn it over back to Scott for his closing remarks.
Great. Thank you, Lee. In our past calls, I've discussed our early efforts to transform our business model to better serve our customers, engage our associates and reward our shareholders, which we've called Flowserve 2.0. This initiative is about taking the best from our past and improving on it for the future. Across the organization, we're changing the way we think, act and operate to better drive growth, improve processes and efficiency and reduce our costs.
As I stated in our Q1 call, the transformation is focused on 6 key areas: operations, commercial, growth, aftermarket, cost structure and working capital. We have largely finalized our plans and are now executing on these initiatives. I will highlight that we are proceeding with a sense of urgency. The transformational change like we're undertaking is not easy or accomplished quickly. This effort will represent a comprehensive change to our business model intended to deliver long term benefits to all of our stakeholders.
While we've seen a few early wins from our efforts, we expect to see significant benefits building later this year and into 2019 beyond. In addition to the work streams that I just mentioned, we are also focused on improving the culture and organizational health of Flowserve. We have made significant leadership changes, including most recently a new Chief Human Resources Officer, a Chief Legal Officer and a new Vice President of Global Operations. Within Flowserve, we are opening the lines of communication, focusing on employee engagement and have made Flowserve's associates a priority. I am confident that all these actions will increase our ability to effectively support our customers, create a more meaningful workplace for our employees and drive significant long term value for We are planning to host an Analyst Day in December to provide an overview of the company and further articulate the initiatives we are pursuing as part of the Flowserve 2 point zero transformational effort.
We very much value our shareholders and analysts and look forward to seeing many of you there. We will provide additional details on the event in the coming months. With that, operator, we've concluded our prepared remarks and we'd now like to open the call to any questions.
Thank And our first question comes from Andrew Kaplowitz from Citi.
Scott, looking at aftermarket bookings, $504,000,000 obviously a good result, the highest aftermarket bookings we've seen in the cycle from you guys. But maybe you could talk about the opportunity to improve on that result. I think last quarter you mentioned that you thought you weren't sitting on your true performance in the aftermarket business. And if anything, this quarter, we've seen industrial and refining related aftermarket work accelerate. So have you stabilized your market share there when you look at your install base and can you materially improve bookings from that $500,000,000 level that's been sort of a key barometer for you guys?
Yes. So Andy, look, we are happy with the bookings that we got this quarter at $504,000,000 and it's nice to get back into kind of a pre recession type of number there. But I would say we still have opportunity here. And so this is one of the work streams within the Flowserve 2.0 transformational office and it's about how do we capture the opportunity we've got to make sure we do a much better job of capturing the entitlement that we have from that installed base. So I'd say our work here is not done.
We're pleased with what happened in the Q2. But I think as we start to really attack the transformation and look at proceduralizing and formalizing Great. And if you focusing on OE bookings for a second, I mean, if you look
into the Great. And if you focusing on OE bookings for a second, I mean, if you're looking to the E and Cs, as I'm sure you do, they're talking about doubling some of them are talking about potentially doubling their energy and chemicals backlogs in the current up cycle. You guys are very levered to refining, Tech Chem, then LNG. So you mentioned the feed activity out there. How does it look in terms of you're still kind of way below your peak.
It looks to me like 70% below the peak in just in any given quarter. So how does it look to sort of get back to that level over time? Could this cycle rival other cycles that we've seen out there? And how do you get there?
Yes. I'd just say, Andy, we're really focused on next quarter in the year. And I don't want to pontificate on multi years out because we're really on a kind of restoring confidence within Flowserve and doing the right things. With that said, when we look at our bookings funnel and the you look at our Q2 numbers, I highlighted some of the big awards. We had a water market for or a water job for flood control.
We did have a nice petrochemical award, but we didn't have any major projects in there. And so I think what you saw in Q2 is that we delivered a pretty nice number over $1,000,000,000 on base or foundation awards And now we're seeing our project funnel continue to increase. And so ideally, what will happen in the coming quarters is that we keep that foundational level, if not grow it, and then we start to add the level, if not grow it and then we start to add the projects on top of that. Now what I would say in the early projects that have gotten released is the projects the bigger the projects are, they're still highly competitive and the pricing isn't necessarily where we would like it to be. And so we feel pretty good about where our plants are in terms of capacity and we're going to be incredibly selective on what we take and we're going to make sure that the margins that we secure in that work are something that we can deliver nice returns to our shareholders.
But overall, I feel really good. I think we're seeing nice growth in all of the markets except for power. Our project pipeline is better and the activity is really good right now.
Just a very quick follow-up for Lee. If you look at currency, if you mark to market on the euro, I mean, we noticed that you kept it sort of where it was. But we didn't pass that 2% significantly at all as we look at the guidance for this year?
And can you restate that again? I'm not sure I caught the question.
So you're based on $122,000,000,000, obviously to 116 nowadays. So how do we think about that in the context of that 2% that you have
in the guidance? Yes.
So I mean the last 3 months, it was a pretty big movement. At the end of March, it was in the 120s. It's obviously the U. S. Dollar strength in the last 3 months.
So we can't necessarily predict where it's going. We just thought it'd be consistent at 122 and our guidance is based on that.
And our next question comes from Scott Graham from BMO. Please go ahead.
Hey, good morning. Nice quarter guys.
Thanks, Scott.
Hey, I wanted to ask about sales and maybe the first question there is if you guys don't mind is telling us what the impact was of the accounting change on revenues in each segment?
Well,
we'll do it in total, Scott, as opposed to by segment, but it was not really material this quarter. Yes.
It's in our disclosure. It was roughly $10,000,000
Okay. And then if since it's not significant, I'm sorry for missing that disclosure, but if it's not significant this quarter, that implies that the second half will be harder hit, which is that the reason why you kind of kept your sales guidance as is? Or is it other reasons?
No. I think our sales guidance is balance of what we see and what we can convert. So listen, we're kind of moving on. 606 is the accounting standard and our guidance is based on that.
Scott, let me just talk specifically on the guidance. And we think the guidance is realistic and I've been here now for 5 quarters. I think this is the Q1 that I haven't been surprised across any of the platforms and we delivered relatively what we expected to deliver. And so I just think at this point, we're not ready to step up or make a change. We really are trying to instill a culture of accountability and ownership within Flowserve.
We've got to do a better job of delivering to our original commitments. And so I think the guidance, when we relook everything and kind of where we're at, it was really about saying, hey, let's make our commitments, let's get a little bit closer through the year. And when we look at the back half of the year, it's a pretty significant step up on the operational income side to make our midpoint of the guidance anyway. And so I'd just say, right now, we're locked in on that. We want to execute to it.
We've got our team driving to the best we can. But ultimately, like I said in my prepared remarks, yes, our internal goals are significantly higher. And we're going to keep pushing and we're going to drive Flowserve to a better place as we move forward.
Got you. That makes sense. So my follow-up is simply based on how you're approaching your bookings. I know that you're saying that you're being more selective. I guess I'm wondering that with the cost structure that was kind of laid at your feet, How much is that impacting your bidding?
In other words, when you say selective, is that selective in the market or is that Flowserve selective because your costs are too high and you actually can't bid on some of this stuff?
Yes. When I say selective, I'm really referring to more of our engineered business and engineered work in the side. And so that's very much a cost based model where we're building costs specifically to the project that comes there. And I'm not going to say that we don't have opportunity to reduce costs there, because I absolutely think that we do. And it actually is 2 of the work streams within the transformation.
It's within our supply chain work stream and it's also in our design to value or just our product strategy approach on getting more configured to order and making manufacturing a lot simpler. But I also think there's an element here of just the pricing side. And we were not as disciplined or as rigorous about really looking at pricing and understanding and really understanding the impact of what that volume at a facility would mean within our overall financials. And so we made some adjustments to that at the end of last year. We've re tweaked that after the Q1.
And I feel very confident about where our pricing is right now to continue to deliver margin expansion from where we are today. That's very helpful. Thank you.
Our next question comes from Andrew Obin from Bank of America. Please go ahead.
Hey, good morning guys. Good quarter. Thanks, Andrew. Hey, just a question. Can you just walk us with some very specific examples because it seems you were lagging the industry for the past couple of quarters, and now you're performing in line or better than other players in your space.
What levers have you been able to pull in the past couple of quarters to sort of get back on track? Can you
describe that in more detail?
Yes, sure. I've been here 5 quarters and so that's as far back as I can go. But what I would say is we've got the team highly focused now and we had to make some changes in certain parts of the organization and so we've got some new players in place and we're very focused. And like I said about the guidance, right, the first part is understanding what we're signing up for both internally and externally and then making sure that we have the plans and the process to deliver those results. And so, while it wasn't in the quarter by any means, it was solid and we had most of our businesses delivering on the top line and the bottom line where they need to be.
We've got a lot more attention, rigor, visibility to what's important and we've got our teams aligned in terms of how do we make that happen. And I think that's probably the simplest way to say it is that we've got a much more disciplined and focused organization today than what it was when I started.
So that should be structurally sustainable then?
I sure hope so.
And then the other question, just thinking about visibility into 2019, one of the big debates, a lot of oil companies are out there saying they're focused on returning cash to shareholders, paying dividends, buybacks, exercising a lot of capital discipline. Without naming any names, are you seeing any of these guys starting to sort of actually talk about maybe in fact spending that cash into 2019 because I think one of the other companies in the industry did highlight that part of their funnel is in fact having discussions with large IOCs and that perhaps they are starting to sort of look at raising CapEx materially into 2019?
Yes. And again, we haven't even started our planning process for 2019 and we're very focused on Q3 and delivering the year at this point. But what I'd say is, as we look at again, we look at what's in our funnel and the activities that we're seeing, it's still very good. And really, when we look at the $1,000,000,000 that we delivered this quarter, there are very few projects that made up that work. And so I think I see an improving project environment as we go forward.
Again, we have to be very selective on what we're willing to take and at what margins. But there's a scenario there where we should continue to build on this base and start to add projects on top of it.
But are you seeing any interest? And as I said, this is not sort of about near term bookings, but are you having any conversations with IOCs about sort of making capacity available for them in sort of second half of twenty eighteen, twenty nineteen and beyond?
No, nothing specific about making capacity, but we are talking we talk to our customers on a regular basis and some of them do share their future plans with us and what they're working on and we feel good about that level of activity.
Terrific. Thanks a lot.
Our next question comes from Charley Brady from SunTrust Robinson. Please go ahead.
Hey, thanks. Good morning, guys.
Hey, Charley.
Hey, I just want to make sure I heard you clearly on IPD as far as margin kind of rest of the year. Would you you're expecting improvement from where we are in Q2 implying that the losses there are essentially done and we're moving to staying at a profitable standpoint from that business?
Yes, I would be really disappointed if we went negative again on the IPD business. And so it's the first time we've gotten back to profitability now in several years. And our plan is to continue to grow from here. And so we've got good line of sight of that. We've got David and the team are executing and doing the things that we need to.
We're clearing out past due backlog and we're clearing out some real low margin work that was in that backlog. And so we do have line of sight to profitability increasing in Q3 and ultimately in Q4 we're still at the target of mid to high single digit margins for that business.
All right. Thanks. And on seasonality, just broadly speaking, I guess, for IPD, but really across the board, any changes to seasonality this year in terms of the timing of when shipments are going to go out? Or is it kind of normal seasonality you expect this year?
Yes. I would say normal seasonality. I wouldn't expect anything different, but we're also on an improved a self help improvement track. And so you should see the self help continue regardless of seasonality.
Thanks. Just one more for me. Bunker fuel regulations for 2020 are getting a little more discussion. I'm wondering as it pertains to Flowserve, what you maybe see as your opportunity there? Are you having discussions with customers today about what they're planning to do and change some of the operations and put new equipment in place to meet that regulation?
I think it's something that our sales team are aware of. I personally am not as dialed into that as maybe as I should be. So I'm going to pass on answering anything specific about bunker fuel at this point.
Thanks.
Our next question comes from Deane Dray RBC Capital Markets. Please go ahead.
Scott, you just mentioned you've been clearing out all that the past due backlog. Can you calibrate that for us? That was a focus last quarter. Is that does that stand today?
Sure. We're still not where we need to be, Dean. But what I'd say is we did make nice progress in the quarter. It's about a 10% reduction across the board. And I'd say that the highlights were IPD and FCD doing what they needed to do in getting that down.
We still got a large project that's in our past due backlog with the EPD franchise. We expect that to clear in the 3rd quarter. And what I'd say is, I fully expect to take another chunk out of this in Q3 and hope to not be talking about past due backlog at the end of this year. And so we are very focused on this. Obviously, it's harming our customers.
But I'd say the other impact is that the longer product stays in our facilities, the more cost it gets incurred. And so it is weighing down on our margins as well. And so this is something we talk about as a management team almost every week and we've got a lot of attention on it. We know exactly what needs to be done. I do expect to get this cleared in the back half of this year.
Now the other thing that I said, I talked about this a little bit in Q1, I'll just reiterate it is that, what it highlighted to me is that our planning competency at Flowserve is not where it needs to be from a as big and as complex of an environment that we work in. And so we've invested heavily on manufacturing and operational planning. And in February, we created the manufacturing and operational organization. We created a more centralized planning function and we're adding resources to this now. And so that's going to take a little bit of time to get kind of best in class on how we think about production planning, materials management, but it is a major effort in the transformational activity and it's an area that we can significantly improve throughout multiple quarters.
Got it. That's helpful. And then on IPD and the pruning of the non core product lines, is there more to do there? And how do you the process, were you looking at these just in terms of pure profit margin or was also the idea of reducing complexity because that was also that's one of your top goals that you've talked about?
Yes. So the 2 that we divested here were it was kind of 2 fold. 1 is they were non core and they were never going to be part of our long term growth strategy. And I think that was probably the single most important factor as we looked at it. And then the second thing is, it was a product line that we just thought was for us to try to get it back into a place that made sense and get it to a market share position and a margin that was acceptable to Flowserve was going require a lot of effort.
And so when we think about prioritization of our resources, we chose to put them back into the core product lines within IPD and we chose to make a decision to put this in a buyer's hands that we think could actually do a better job than we did. And so we've been working on this divestiture for some time. And unfortunately, when you're not making money, it's hard to sell businesses. And so it's been a little bit of a complex process for us. But we're happy to get this signed and we will close it in the Q3.
And it will really help David and the IPD team focus on what's important and start to grow our business and grow the product lines that are core part of IPD.
Got it. And then
just last question for Lee. When Scott rattled off the 6 focus areas for Flowserve 2.0, the 6th one was working capital. Do you have any specific goals today that you can share a timeframe to hitting those? Is it 4% as a percent of sales? And any calibration would be helpful.
Yes.
Sure. So listen, where we are today is far from world class. Our DSO is currently at 75 days. Our inventory turns at 4. That does not include the impact of contracted assets.
Our aspiration is to get to what I would consider as, I don't necessarily world class, but we're reasonable class. And so there's a significant amount of resources attacking our receivables, looking at the whole process, that whole order to cash process. And as Scott said in his remarks around S and OP, we're completely looking at our planning, our orders planning process to drive that. So it is something that we look at, at a regular basis. There is significant amount of intensity, and our aspirations are to get where it should be.
Every investor is looking at us as what we're doing on working capital, and we hear it. So we are putting plans in place, and I expect around the December time frame, we'll communicate those plans.
Thanks, Dean.
Our next question comes from Joe Giordano from Cowen. Please go ahead.
Hey, good morning, guys. Hi, Joe.
So as orders pick up and mostly maybe OE orders start to pick up and start to become a higher percentage of the mix there? How do we think about margin potential headwinds to margin as you go forward there? And how should we think about potential for cost needing to return to the business that you've been kind of lean on this year into next year?
Yes. Joe, I think it's a really good question. I would say under a normal circumstance, those would be headwinds for us. But I'd just say we have a lot of opportunities on our cost structure, both in the product cost and on the overhead and organizational costs. And so again, with the Flowserve 2 point zero transformation, I think we continue to make progress in both margin categories.
And I guess, we've
got a lot of room
to work with. And so I won't we're not going to let mix or an OE versus aftermarket dampen anything at this point, we're going to continue to progress margin expansion. And then the other thing is that our facilities today are not as full as they need to be. And so with the additional work, we start to absorb a lot more and that's going to take out a pretty significant headwind of cost that's still in the business today.
Okay, fair enough. And then when you're looking at bidding for newer projects, I think obviously before you were there, you got into some trouble with kind of not just the discipline on the total price, but maybe not evaluating all aspects of the project. Like how are you factoring in the complexity of what you're being asked to do or the risk of who the counterparty is given all the write downs in like Latin America? Do you feel like now you're getting if you're going to take on something like that, it's factored into the model and you're going to be compensated while in excess or at least adequately for that kind of stuff?
Yes. This is really relating to the Engineered Products division. And again, we put in a lot of scrutiny on what comes into the pipeline and what we're willing to take. And so I'd say, Flowserve has learned a lot over the last 5 or 6 years on how should we contract big projects, how do we mitigate risk and how do we execute. And so I don't anticipate to go backwards in that regard, but we have not we have only improved our scrutiny of not only on pricing and margins, but how do we execute the project and the terms and conditions that we're willing to accept.
And then last for me. You mentioned when we all got together months ago about like the under penetration of automation within your footprint. Has that process kind of started? Have you started to invest there and deploy some of that technology? Or that more of a 2019 and further kind
of Yes. You're referring to manufacturing specifically, right?
Correct, yes.
Yes. So yes, we are lacking in manufacturing automation systems improvements to support the transformation and manufacturing systems improvements to support the transformation and manufacturing productivity or basically automation within the manufacturing. And so we really have not begun that journey. We just secured a new Vice President of Global Operations last month. And so we've got him traveling around the world now visiting facilities, but we're going to give him a lot of freedom in terms of putting more technology into our facilities and making sure that we can be
Thanks. Good morning. Hi, Steven. Hi. Can you guys just remind us what your opportunity set is on LNG plants?
How big could your scope be on these projects?
Yes, I don't want to quantify the scope on LNG, but what I can say is that it's one of the few areas that we're doing a pretty good job of making sure that the pump offering and the valve offering can come together and we can be more of a combined proposal into that market. And so if we do things right, it's probably the best opportunity for us as a Flowserve company when we think about Flow Control. So we're excited about the outlook of LNG. We're in active discussions with a lot of different customers at this point. And again, it's an area where we we can bring valves and pumps into the foray and I think we can do pretty well
there. Okay, great. And on the guidance, I completely understand that you want to be accountable for delivering what you promised. But I'm wondering, is there anything specific that you would have concerns about or things that could still move around, be it input costs or timing of any certain projects or anything like that?
Yes. Let me I'll start with that and I'll turn it over to Lee. But again, yes, I've been here 5 quarters and we've had one that's been somewhat respectable and without major surprises. And so for me, it's just it's really around getting the operational discipline to deliver our results and not have major surprises. And so the back half of the year is still a challenge and I don't think we're not running this business as well as we can and we still need to improve.
And so we're on a continuum of our journey and I don't think there's going to be major surprises to the downside. But at this point, again, we're not we don't have the competency in the process controller adherence that we would want as we think about where we should be from an operational and a manufacturing company.
Yes. Just as a reminder, the midpoint of our guidance is an 18% improvement year over year on EPS. We still have a long way to go. As we sit here today, we're at $0.68 adjusted. We need to improve our back half of the year by 40% to hit that guidance.
So I think our range is realistic, but as Scott has mentioned, our aspirations are greater.
Great. Thanks very much.
Our next question comes from Joe Ritchie from Goldman Sachs. Please go ahead.
Hey, good morning guys. This is Akshay on for Joe.
Hey, Akshay.
I guess just touching on orders for a second, could you talk about your confidence in sustaining this $1,000,000,000 run rate going forward now that aftermarket is hitting $500,000,000 and the project funnel is growing?
Sure. I mean, we obviously don't want to go backwards. And so for us, the funnel looks good. The activity is in a better place than we've seen. And we feel pretty good about the outlook in the back half of the year.
The concern is project timing and awards. And so that's what we're watching and we're trying pull those forward and lock them into Q3 and Q4. But our intention is to capitalize on the momentum that we started in the second quarter.
Got it. And just touching on cash flow for a second, nice to see the focus on working capital, but could you touch on CapEx requirements in the next year again as you start taking more orders like is $80,000,000 to $90,000,000 sort of going to be the run rate or do you have to take it up further? Thanks.
Yes, I'll start with that and then turn it over to Lee. But I think $80,000,000 to $90,000,000 is a pretty good number. I don't see a material need to drive that up significantly higher. On the other hand, the one thing that is definitely going to cost us money as we move forward is, and we said this, part of our enablers in the transformation is our IT infrastructure network. And right now, we're running on a lot of different ERP systems.
And so the cost to get off of those and get to a more consolidated basis is going to cost money. And so the big question is, can we do it within the range of kind of an $80,000,000 to $100,000,000 or do we have to move that up a little bit? But at this point, I don't see any need for a major roofline expansion exercise. We've got facilities in the right locations. We do need to invest in manufacturing technology.
And so I think as we go forward, it's just a combination of IT and manufacturing technology, and I think we should be somewhere in that range.
Yes. I'll just support that comment that what we're spending a lot of time is try to spend the money smarter and more wisely. Historically, I would say there was somewhat of a peanut butter approach to where capital is allocated. We're developing a much more enterprise view, and the most urgent projects are getting the capital where it's more consistent with our overall enterprise strategy. So as Scott has mentioned, the one outlier is potentially on the IT side, but we feel that we can still address the needs of the business and better put that capital to use with better processes.
Got it. Yes.
And just I mean, just to build on it, we did we brought our top leaders in about 100 people here 2 weeks ago. And one of the big things that we're trying to do is improve the financial acumen across our enterprise. And so Lee spent a whole session on return on invested capital and what it means and how driving working capital down and how spending our money wisely can help return for this business and for our shareholders. And so we are getting much smarter and more strategic about how we do that and where do we deploy capital and what the best use of cash is. And so I think as we go forward, you'll see a pretty marked improvement there and a lot more focus on what we do with that resource.
Thanks, Scott.
Our next question comes from Adam Farley from Stifel. Please go ahead.
Hey, good morning guys. Thanks for taking my questions.
Yes, good morning.
First question is around geographic strength. You called out the Americas, Latin America, another area. Can you just talk about give a little more color about what areas of strength seeing? And then also for the rest of the year, what geographic regions do you think will be strong?
Sure. We're doing well across all markets, but let me just kind of run through them. In North America, really the growth there has been on the upstream side where Flowserve does not have the offering that we would like. And so one of our strategies is start to migrate some of the products both in pumps and valves into more of the upstream and midstream space. And so I'd say, we're a little bit stream and midstream space.
And so I'd say, we're a little bit underrepresented there, but we have the ability to start to grow and move more products into that with the existing technology. But I don't see any change in North America. In fact, on the downstream side of North America, I see opportunities. And so that should be an area that improves and we get better. And then additionally, in the petrochemical side of North America, we feel pretty optimistic about that as well.
The areas of growth for us would be the Middle East and Asia Pacific and both on the downstream oil and gas side and the petrochemical. And that's where we're starting to see a lot of projects line up nicely for us. And we anticipate winning awards there in the back half of the year and into 2019 is that pre feed and feed pipeline continues to grow. So we feel very good about that infrastructure investment and things going there. Europe is it's not bad for us and we had a solid quarter, but I don't see tremendous growth there.
And then Latin America, I don't think we're ready for Latin America, while it's going to improve, it's off a really, really small base. And so we don't expect anything outsized in Latin America in the next 12 months.
That's really helpful. And then just shifting gears, you guys have been very clear on the need for operational excellence and you're doing a lot of work there. You're doing some divestitures of non core product lines. I was wondering about M and A. Just maybe talk about the pipeline there.
If there's any like potential tuck in acquisitions that you're looking at?
Sure. Yes, I mean both the pump and the valves space is highly fragmented, right? And so by definition, there are a lot of opportunities. And I'd say, even in the last 6 months, we've seen a lot of things come on to the market and a lot of things that are speculated to be on the market. And so it's a pretty dynamic landscape right now.
And I'd say ideally, at Flowserve, we really want be in a position that we can start to consolidate and be acquisitive, but be acquisitive on things that make sense, right? So things that come in and fit our technology portfolio and align nicely with our long term strategy and have the ability to leverage the aftermarket and QRC network that we have. So as I get more confident in our ability to exercise or our ability to execute, then I think you can see us be less defensive and move more offensive on the offense. But I'd say at this point, we're not there. We've got to start to improve with the working capital and the balance sheet items and we've got to continue to get consistent with our operating results.
But at some time and hopefully it's more in the near future, we can start to talk more positively about being acquisitive on the growth front.
Great. Thank you.
Our next question comes from Walter Liptak from Seaport Global. Please go ahead.
Hi, thanks. Good morning and congratulations Scott and Lee. Yes. Thanks Walter. So I wanted to go back to the divestiture.
It sounds like they're small, but I wonder if you can talk to us about the cash inflow we might see from in the Q3? And then is there going to be like a restated ops because of this or discontinued app?
Yes. I'll take the over and then I'll let Lee answer the specifics there. But I mean, look, this is an underperforming business that hasn't made money in several years. And so you're not going to see anything come in on our side. Lee, do you want to talk about the Yes.
It's a pretty like
I said, as we disclosed, it's a very small business and like some of our prior smaller disposition, we have not restated our financials and treated the discontinued business. So it will be a variance for next year as far as the revenue side. It will actually be accretive on a profit side.
Yes. So the results of this business were in our Q2 numbers. They'll be in our Q3 numbers until we close the business. Yes.
Okay, great. So it's already in the guidance?
Yes.
And what are if you split those businesses out, if you exclude them from IPD's operating margins this quarter, where would margins have been?
Yes, we don't really want to get into the specifics. But what I'd say is, again, it was a loss making business and it lost money year to date, but it was a marginal loss. And so it's
It's $10,000,000 per quarter. The revenue is $10,000,000 a quarter. And so it's this is not earth shattering. This is just it's opportunistic to get out of a product line that doesn't make sense and focus on what's important.
Okay. And the last the other one, just a follow on, on the downstream comment that you just made about the funnel for the back half looking good. How are you addressing pricing? Within the funnel, are you able to get pricing? Are the margins expected to be good on the new business?
Sure. And so as we keep talking about, we are highly focused on margin expansion and getting the right work into the backlog that we know we can make money on. And just as a reminder, from what we talked about in Q1, and so we've actually done 2 price increases at the beginning of the year. The first one was just kind of a we hadn't done in a long time. We started to feel a little bit better at the market.
And so we did a relatively kind of across the board price increase. And then on the back of the steel import tariffs at the end of Q1, we did our second price increase. And so that would be more on our configured order in our base product. And so I feel very good and comfortable that we are in the right side of the price cost equation and we're going to start to see that show up in the margins. And then on the EPD or the engineered to order side, we've been very ambitious about what we can get in that space.
And what I would say is in Q2 or in the end of the year, Q4 and even into Q1, we had raised our prices pretty significantly. And as a result, had missed some orders that we were really would have liked to receive. And so we've adjusted that moderately. But what I would say in that business is that even with where we are today, we feel very good about the work that we're winning. And we think that and what we know that the margins will be accretive to where we've been over the last couple of quarters at Pluserve.
So I feel very good about our pricing and where we are with the inflation and the tariffs. And the other thing I'd add is just we still have a lot of room for improvement here. And so a lot of this has just been more looking at being reactive to what's happening in the marketplace. And so now as part of the Flowserve 2.0 transformation, we're putting analytical tools and really taking a much more methodical approach to pricing and using data to help us and make much better decisions. And so we're actively in the middle of that and it's a major initiative for us.
And I think we're going to see nice results and certainly some market tailwinds here that's going to help us capitalize on that as we go forward.
Okay. Sounds great. Thank you for that answer.
Yes. Okay, great. Hey, I do want to go one back the question back that Charlie asked about bunker fuel and what we were doing the regulatory changes there. So I've received a note now and I've got a much better answer. But that does impact our bookings and really over it will impact bookings over the next couple of quarters and it's something that our team is highly aware of and we've got a very nice product offering that supports that change.
And so we feel good about the ability to capitalize on that and I think we'll see that in the back half of twenty eighteen.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating and you may now disconnect.