Good morning, everybody, and welcome to Flowserve's 2018 Analyst Day. We really appreciate so many of you joining us here in person in New York today. This really is a terrific turnout and we thank you. I also want to thank the people who are participating with us on our webcast today. At last check, we had a sizable audience online.
I'm Jay Roush, and we are really excited about the opportunity to be with you today and to share with you more information about Flowserve, including where we are, what we're doing and what to expect in the future. As is typically the case, let me begin with some housekeeping items. As you'd fully expect, today's presentation and commentary will include forward looking statements and will utilize non GAAP measures. Encourage you to read the disclosures on this page and to review our reconciliations from GAAP to adjusted that we provided for you in our appendix for more information. As we always do at Flowserve, let me begin with safety.
We're not expecting any planned drills today at the hotel. However, if there is an emergency event, we're going to shelter in this room unless instructed otherwise on the PA system. The ballroom has multiple exits. There's a depiction of them on your screen. You saw them when you walked in the room.
So make yourself familiar with them in case we need them. We have a pretty full agenda this morning. We're expecting this event to last 3 or 4 hours and we'll take a break around the halfway mark. In addition to the executives listed here, I'd also like to take a moment to introduce Mr. Roger Fix, who is Flowserve's Chairman of the Board and appreciate him being out today.
If you would please save all your questions until the end of the presentations instead of asking them as we go along and we'll have a comprehensive Q and A session at that time. And with that, I'd now like to turn the stage over to Mr. Scott Rowe, Flowserve's President and Chief Executive Officer.
All right.
Thank you, Jason. Good morning, everybody. Thank you for your participation and your interest in Flowserve. As Jay highlighted, we do have a comprehensive update and overview today. So I'm going to start with the company overview and some investment highlights and what we're doing.
Then we're going to turn it over to the Platform President, who will stand up and talk respectively about each of their businesses and what they're doing and how they're moving forward. We'll also do a spotlight on technology. And you can see we've got a demonstration here. So we'll do a live demonstration. This is our Mark III.
It's a Durco pump Mark III application. It's the workhorse in any chemical application. And so we'll go through a spotlight on technology or about predictive analytics and reliability based solutions. So I think you'll enjoy that. I'll come back up after that and we'll go into details about our Flowserve 2.0 transformation.
Lee will talk about financials and give a little bit of our outlook on our expectations of what the transformation could provide for the future. And then I'll come back and close it out with the summary at the end. Let's just jump into the Flowserve overview and the investment highlights. So Flowserve has a distinguished history serving our customers and products for over 200 years. We have a balanced and diverse portfolio with flow control products.
We believe our markets will grow with the opportunities over the next several years despite the recent volatility in the current marketplace. Flowserve has a significant installed base, and we believe that we can continue to capitalize on that installed base. And we'll touch on that through many different themes throughout today. We are currently in the process of transforming our company for the future under Flowserve 2.0. We have a strong financial position today.
We fully expect to improve upon this. Let's talk about our history. Flowserve has a long and rich history in the flow control industry. We started as Simpson and Thompson in 17/90. Flowserve was built through many acquisitions over the last 200 years, and we continue to support our customers and their most challenging flow control solutions.
Here's Flowserve at a glance. We have 17,000 employees in more than 50 countries around the world. Flowserve goes to market with 50 leading brands, and we touch more than 10,000 customers each and every year. We have over 5,000,000 unique pieces of equipment installed and operating that we service through a broad network of 181 different QRCs or Quick Response Centers. Flowserve has a balanced and diverse business model.
We're balanced by geography with 60% coming from North America and Europe and 40% coming out of the faster growing emerging markets. We are balanced by our platforms, and again, we'll go into details on each of these platforms. And we are balanced by end markets, oil and gas representing about 40%, chemicals representing about 20%. Those are our 2 largest markets. And then finally, we are in a unique position due to our legacy and our installed base to have nearly half our business represented by higher margin recurring aftermarket business.
Let me spend a little more time on the our aftermarket was down only 12%, and about half of that decline was driven by currency with the strengthening U. S. Dollar. The FLORZOVAZ aftermarket business is highly resilient to market condition and commands higher margins throughout any market environment. We capitalize on this through our extensive QRC network and our differentiated full lifecycle business models.
This is an important part of Flowserve, and again, we'll go through this in the transformation, and Kirk will talk about our aftermarket strategy and how we manage this business and how we expect to grow it. Another differentiating factor for Flowserve is that we are the only company with a significant in pumps, valves and seals. Flowserve controls fluids and gases with our valve offering, and our pumps provide the energy to run our customer applications. Additionally, our Seals products provide the protective barrier needed to keep these processes running and operational. This product synergy and integration allows us to uniquely service the $145,000,000,000 total available flow serve market or flow control market that's at our disposal.
Let me share with you an example of the flow control pure play. So this slide depicts a typical 400,000 barrel per day refinery unit. So as you can see here, this typical refinery has 500 pumps, 700 seals and approximately 2,000 valves. A refinery like this has several different units, and I want to focus on the isomerization unit. That's the unit here on the top right side.
And the example we want to spotlight, this is a P and ID of a vapor recovery system within the ISO unit. What the vapor recovery system does is it eliminates flaring due to the recent regulation to reduce greenhouse gases. So in this specific application, vapor recovery system, Flowserve has several different opportunities to provide our products and our services. So the first here on the bottom left is an industrial pump. This is a liquid ring compressor with seals.
We also have an engineered pump that's part of this application. We have isolation valves and we also have control valves that play in this. Now there's 4 or 5 different vapor recovery systems across this refinery and there's also different applications for pumps and valves in the different units of the refinery. Also with our aftermarket, we're uniquely positioned support our customers with their forward control needs, including all of our aftermarket services and reliability based solutions. The other thing I'd just say on this is product integration and bring all the resources of Flowserve to bear is important part of our strategy and is an important part of providing this comprehensive flow control support to our customers.
Here are a few underlying factors that drive the markets that we serve. I'll highlight a few of them that are the most relevant. In macroeconomics, there's GDP growth and the increase in standard of living. These are 2 areas that will continue to grow into the foreseeable future. Under industry specific, we have commodity prices such as oil price, natural gas and NGL pricing.
Additionally, the aging infrastructure requires additional capital to maintain and keep facilities running. In other factors, there's regulation change and domestic investment are the 2 largest drivers for capital spending. Anytime there's a major regulation change, like I talked about with vapor recovery, it drives opportunities for Flowserve. Additionally, the renewed focus agendas is also providing significant opportunities for Flowserve. While the markets have recently been volatile, the underpinning factors that drive our business continue to point to long term growth.
I'm confident long term trends of GDP growth driven by the developing non OECD markets for countries as well as the outlook for energy consumption. While renewable energy continues to grow, demand for oil, natural gas and nuclear will also continue to grow. The markets will always have volatility in the short term, but both GDP and energy consumption will grow for decades to come. So let's look at capital spending. So first, it was driven by industrial capital spending in oilgas, chemicals, power and general industries.
This graph represents the rate of change in each of the 4 categories. Anything above the 0 line, the line there in the middle, reflects growth in capital spending year over year. In 2017 2018, capital spending was above the 0 line and growing in all four of our categories. I feel good about capital spending continue to grow for the next couple of years in all of our markets with the exception of power. And while the data and the graphs are nice, we are also talking to our customers, and we continue to get and they continue to reiterate growth in capital spending for 2019.
Let's transition now to our customers. There is a small representation of the 10,000 plus customers that we work with on a daily basis. At Flowserve, we serve the premium names in each of our core markets. We have a long history with many of our customers, and we are in a privileged position to be on most approved vendor lists around the world. All right.
So let's shift now to the journey that Flowserve is on. Before I go into the future, I think it is important to reflect just briefly on the past. Historically, Flowserve had performed well in the up cycle with a decentralized and local operating model. You can see the revenue growth and the incoming growth during this time, right. So these are the lines.
You can see revenue growing, the dotted line is income. And in the up cycle, it worked really well and income margin was expanding as fast as revenue was. The model worked well in the up cycle. However, it didn't work well in the down And you can see in 2015, the disconnect with the two lines. In the downturn, the model didn't work as you had profitability declining significantly faster than revenue.
And part of this was due to the model was not scalable, we had limited cost flexibility and had no ability to leverage the knowledge and best practice that was resident within Flowserve. Our goal with Flowserve 2.0 is to create a model that works in any operating environment. So let's turn now to our journey. There are 3 phases in the Flowserve journey: stabilize, transform, and then ultimately optimize. I started in Flowserve in April of 2017 and stability was very much needed after 3 years of the downturn with multiple rounds of reduction and closing facilities under the realignment programs.
The next phase is transformation or Flowserve 2.0. I'll go into great detail about this in my next segment of the presentation. The final phase is the optimized phase of the future state of Flowserve. This is where we want to be after we finish the transformation. And we'll go into each one of these as we go out through or go through the presentation today.
Let's first talk about actions to stabilize and what I was facing when I first came to Flowserve. It was clear to me that we needed to flatten the organization and open the lines of communication. I also knew that we needed to add key talent and elevate some of the critical roles within the company. And finally, we needed to align strategy through execution with common language, purpose and objectives. We were missing many pieces of the strategy pyramid that you see on the right of the slide here.
Needless to say, there is a lot that needed to be done in my 1st years at Flowserve to stabilize the company. Let's go through a few of the actions that we've taken place. So I started by assembling a strong team that was committed to our journey and driving the effort needed to change our company. So I'd like to introduce the executives that are here with me today, and we'll just go left to right. So first, we've got Kirk Wilson.
Kirk leads our aftermarket services business. Thank you, Kirk. We also have David Wilson. He's the President of our newly formed pump division. David, thank you.
John Monander, President of our valves division. All right, John. Lee Eckert, CFO. Thank you, Lee. And we have Lanisha Minix, General Counsel and Eric Van Geberen, who wears many hats.
So Eric is currently leading our transformation office. I had originally had Eric leading marketing and technology for us today. We've moved him over to the transformation because he's the most capable to lead that for us, and we currently have an open position with marketing and technology that we expect to fill in February of next year. In addition to the changes here, we've also elevated some key roles that are important to me and important to transforming our company. So first is the CIO position.
So we've got Doug Short. He's new to the organization. So everybody in a red box is new to our team. Doug's leading IT, and we'll talk about the IT enablers for transformation and why it's so important for Flowserve for the future. We also created the marketing and technology position.
We elevated that, and essentially, that's been very proactive with our market and tying our product offering and our technology investment together to make sure we're better serving our customers in the markets that we think we have opportunities in. And then finally, we added a role of operations that's on my team and reporting to me. Richard started over the summer as an expert in manufacturing, comes from many years of doing manufactured products in the pressure control space. And so Richard started this summer. He has both manufacturing and supply chain worldwide at Flowserve.
The next thing we had to do is create a purpose statement and instill pride with our associates. We ultimately want to be a purpose driven organization, and I tasked a group of associates to create the new Flowserve purpose statement. This is what our team came up with. Together, we create extraordinary flow control solutions to make the world better for everyone. We launched this in January, and I'm truly excited that our 17,000 associates have adopted this and picked it up with enthusiasm.
Let's talk about how we put our purpose statement in action. Volser was selected to provide pumps for the Afla Dijk flood control project in Holland. The Dijk system is critical to keeping the Netherlands dry since most of the population in Holland lives below the sea level. FlowSilver was awarded the critical pumps for this project in Q2 of this year. These are the largest diameter pumps that we have ever made.
They also have a unique and proprietary fish friendly design with the impellers, and they are capable of pumping over 6 Olympic sized swimming pools every minute of operation. A lot of water pumping out through the system here. Throughout the day, you'll continue to hear examples of how we're bringing our Flowserve purpose statement to life and making the world better for everyone. In January, we also introduced the Flowserve core values. Again, we tasked a group of employees develop our core values that would guide our organization into the future.
The group came up with people, safety, integrity, ownership and in our aspirational values of innovation and excellence. And at Flowserve, this is now how we run our company And our leaders and managers live and lead by our core values. We bring these values to life every day with values moments, how we recognize our employees, it's how we select and promote, and it really is instrumental to our day to day at Flowserve. So 2018, we've made a lot of progress over the last 20 months. We have stabilized the business, and we've taken a good first step on our journey.
We have made progress, but we are still very much in the early phases. In the year, we put new leadership team in place. We've improved the functional support model. We've launched a new purpose and values at Flowserve. On the process side, we've launched the Flowserve 2.0 transformation, We've aligned on strategy through execution.
We have committed to an enterprise mindset and putting Flowserve first. And then finally, on the financial side, we've improved our operating margins, enhanced the visibility and focus on working capital, and that we have improved our financial returns. While I've done some good things this year, we still have a long way to go on our journey. I would now like to turn the presentation over to our platform presidents. I'll come back after the technology section to discuss the transformation in more detail.
So I'd first like to welcome John Leneander to the stage. John runs our valve business.
Good morning. My name is John Linnander. I run the Flow Control business. I've been with Flowserve for 12 years running various P and Ls. I have 40 years in the valve and actuation business with the earlier part of my career having been spent in global sales.
Another example of Flowserve's purpose statement in action, where we make the world a better place for everyone, is in the application of our products in the fast developing area of concentrated solar power. Flowserve pumps, valves and seals have taken a global market leading position in this severe service, high temperature application where molten salt at 1,000 degrees Fahrenheit is pumped and flows from a receiver tower through storage tanks to steam generators to produce electricity. To date, we have participated in over 50 projects around the world in Europe, Africa, the U. S. And China.
Due to the critical and difficult operating conditions, our customers value the performance of our product, the commissioning and aftermarket support services we provide, and this makes us the flow control leader in this growing niche power segment. So I am extremely excited to be here today for the opportunity to share with you more details about Flowserve's valve and actuation business. The strength of FCD is around our broad portfolio of primary and complementary products with strong brand recognition, and we serve diverse markets from oil and gas through general industries. The $75,000,000,000 total available market for valves and actuators is highly fragmented. There's lots of competition.
However, most of our competitors tend to be narrower in product scope and in the markets they serve. As such, Flowserve's competitive advantage is our ability to integrate products, create global customer alliances and provide broader aftermarket service and support. Our customers value our global reach with worldwide manufacturing locations and strategic QRCs, all supported by a large, low cost, quality focused manufacturing footprint in India and China. We span multiple routes to market with 60% of our sales, direct to end users, EPCs and OEMs and 40% being sold through distribution. When looking at our end markets, the best way to describe FCD is that we are balanced within our key industries served.
Oil and Gas and Petrochemical represent our strongest markets, but we compete well in multiple industries. Historically, FCD was very North American and European centric, but we have done a good job in balancing our regional mix and are now growing the fastest in Asia Pacific and the Middle East. This growth has allowed us to expand our reach and maintain our solid margin profile as competitors with narrower scope struggled during the industrial recession. Aftermarket in OE tends to run a little bit together in our business. We are strong in the greenfield project business necessary to expand our installed base, and we then have the capabilities to harvest the aftermarket through our QRC and distribution network.
Opportunities within MRO represent the majority of both our aftermarket and OE mix. Our Control Valve business, which is our largest product line, is a perfect example of this. After the OE project sale, the residual aftermarket revenue stream is approximately 4x the initial project sale price for the remaining life of the control valve or in the event the customer prefers to repair by replace with the installed base in a long history of support services from the QRC, we sell another replacement valve. When an end user or an EPC thinks about doing an enterprise frame agreement or an alliance with a valve manufacturer, they focus on 3 key areas, which are control valves, trunnion ball valves and automation. These products not only represent the largest spend for the client, but also are the most critical to the success of the process stream or project.
FCD is well positioned with these 3 primary products. And in fact, they make up 75% of our revenue and serve as the anchor products for pulling through our complementary, adjacent and niche product lines. FCD's solid financial performance through the cycle is attributed to a number of factors. First, we have a strong long term relationship with many key global customers. Our solid operating platform with core brands and products combined with a record of on time performance ensures that we are a partner that can be relied upon.
Our balance in industries and regions served in excellent aftermarket capabilities has allowed us to manage our business better than many of our competitors. While our business is performing solidly, the operating model envisioned by Flowserve 2.0 provides significant opportunities for FCD to improve our business through process and technology, customer focus and operational excellence. Our strategies are to invest in new and product adjacencies, take cost out of our existing portfolio, capitalize on the power of the pure play to get closer to our customers as we globalize our core brands and leverage the Flowserve QRC network to support them better in their local markets and finally, to become an even more reliable partner. We are truly excited about the future of our business and the value it will bring to our customers and associates. Thank you very much for being here today and allowing me to share my enthusiasm for my business.
And at this point, I would like to turn the presentation over to Mr. David Wilson.
Good morning, everyone. My name
is David Wilson, and I'm responsible for Flowserve's Industrial and Engineered Product Businesses. I joined Flowserve 15 months ago as the President of the Industrial Division. And in July, I added responsibility for our engineered business. Prior to joining Flowserve, I had responsibility for leading businesses across a diverse range of markets and industries at SPX Corporation and thereafter SPX FLOW. I also have extensive experience in Asia Pacific, where I lived and worked for the better part of a decade, developing effective teams in high performing businesses.
You'll recall from Scott's opening remarks that our purpose statement is, together, we create extraordinary flow control solutions to make the world better for everyone. Like Scott and John, I'm going to begin my section of our presentation with an example of our purpose in action. On the screen you see images of the City of Dallas, where it's located on the Trinity River, it does require protection from flooding. In Q4 of 2015, Flowserve received a large order for the 3rd phase of a project to upgrade the pumping stations in the city's 22 mile levy flood based based for flood protection system. This followed Flowserve's successful execution of Phases 12 for that project, where Flowserve's concrete volute pumps dramatically improve the city's ability to protect itself from flooding, alleviate infrastructure and environmental damage and prevent injuries and potential loss of life.
It's a hallmark of Flowserve's culture to be highly engaged within our local communities, and it's a privilege to have been selected to protect our home city in this critical area with our leading concrete blue technology. This is one of the many applications where you can see FlowServe's purpose in action and our solutions making the world better for everyone and in this case, Dallas specifically. Our engineered products organization serves global demand for its leading products and services via 30 plants and 123 QRCs. Over the past few years, we've been making strategic adjustments to this footprint and it's now situated as you can see outlined on this slide. We have a broad and well positioned engineered product portfolio, selling under highly recognized brands and supported by extensive design and application expertise.
Our original equipment largely serves greenfield and brownfield project activity and is sold primarily, but not exclusively through Flowserve's direct sales channel. Given our success in the market over many decades, we have a large global pump and mechanical seal installed base. The recurring needs of this installed base are served via our extensive and capable network of centralized parts manufacturing hubs and strategically situated QRCs. Flowserve's centrifugal positive displacement and specialty pumps and systems are key components in the worldwide oil and gas, hydrocarbon and chemical processing, power generation and water resource industries, as well as the general process and industrial marketplace. Flowserve pumps play a leading role in clean energy, greenhouse gas, reduction and potable water supply efforts along with the application of advanced production and process technologies.
Today, our engineered products booking mix is primarily weighted towards the oil and gas markets, followed by a fairly balanced mix of chemical, general industrial and power activity. Water makes up the remainder of our mix. While there are attractive growth opportunities in each of these markets, we would highlight those opportunities in the refining, midstream, chemical and LNG markets. Our year to date geographic sales mix for Engineered Products is primarily weighted towards North America and Asia Pacific. Europe, the Middle East and Africa and Latin America round things out.
Aftermarket sales make up 70% of our total sales mix and original equipment makes up 30%. We remain focused on developing and expanding our overall capabilities in Asia Pacific and more broadly advancing our technology in support of total cost ownership solutions for our customers. Flowserve can trace its expertise in the pumps industry back all the way to the 18th century and the earliest application of steam pumping engines. Since then, Flowserve has grown into a driving force in the global pump marketplace. No other pump company has our depth or breadth of expertise in the successful application of pre engineered, engineered and special purpose pumps and systems.
In addition to offering more than 100 distinct pump models, Flowserve provides its customers with unequaled engineering and technical support with the industry's most progressive hydraulics, mechanical materials, monitoring and diagnostics capabilities. These attributes and more physician flow serve as an attractive partner on almost every approved vendors list in our industry. On this slide, I highlight a few examples of our highly competitive engineered products. On the left, you can see examples of our concrete volute pump pull out units. These are similar to those that I referenced in the City of Dallas project just a moment ago.
In the center, you see an example of a multistage refinery pump,
a highly utilized process pump
where high levels of reliability and availability are required for critical applications. Finally, on the right, I've highlighted an example of a single stage pipeline pump, which is part of a field proven wide ranging product line that's best situated for high flow medium pressure application. Shifting our attention to the financial performance of our Engineered Products division. Here you can see our trended revenue, operating income and operating margin performance between 2011 and the trailing 12 months ended Q3 of 2018. You may recall Scott's earlier comments regarding the resiliency of our aftermarket activity and note that the majority of EPD's revenue decline over this period was driven by a reduction in OE activity.
Over the past year, we have stabilized performance following these declines and have begun to deliver improvements. Significant efforts to rationalize footprint and reduce structural costs, combined with an unrelenting focus on operational excellence and product cost reductions has positioned EPD for improved flexibility and margin expansion. Like our Engineered Products division, our Industrial Products division serves global demand for its leading products and services through a similar network of plants and QRCs. This network, which has been strategically adjusted over the past several years, now consists of 19 plants and 30 QRCs that are strategically situated as you can see outlined on this slide. Similar to EPD, our industrial business has a broad product portfolio selling under highly recognized and in many cases the same brands as our EPD organization.
These products are sold in a diverse range of attractive end markets through both direct and indirect channels. We are making investments to enhance and further develop this portfolio, and our industrial products are generally shorter cycle in nature and are manufactured on an assembled to order or a made to order basis. Given our success in the industrial markets over the last several decades, we have a large global installed base that presents further parts and aftermarket service opportunities for Industrial. Our Industrial Products bookings miss is weighted towards the general industrial markets, followed by the chemical, oil and gas, water and power markets. We believe that there are attractive growth opportunities in each of these markets and we are positioning the business to capture more than our fair share of these opportunities as we improve operational performance, reduce our past due backlog, improve on time delivery and expand our distribution coverage.
For example, in Chesapeake, Virginia, where we manufacture our Durco MK3 product line, and you'll recall Scott referred to our Durco product over here on the stage. We had product configurator errors that prevented customer quotations from being able to advance automatically into Flowserve as orders without the intervention of 1 of our technical specialists. Those challenges have been reduced from an occurrence that was 40% of the time now to 20% of the time over the last year. During the same period, order entry type cycle times were reduced from 8 days to 2 days. Past due engineering documentation has been reduced from 10,000 items, now it's at 0 items.
Past due product deliveries have been reduced from over 130 units down to 26 units, our lowest level since July of 2016. And on time delivery has improved from approximately 35% when we were struggling with poor supplier performance and supply chain disruptions to greater than 80% overall. And when looking at Mark III products that have lead times less than 8 weeks, our on time delivery performance is greater than 90%. While these aren't our end goals, there are significant improvements in the business that indicate the progress we're making. Underpinned by these improvements, year over year orders for our Mark III products are up 13%.
And this is why I've indicated that we're positioning ourselves to capture more than our fair share of the market opportunities ahead of us. Our geographic sales mix for industrial products is primarily weighted towards North America and Europe, followed by Asia, the Middle East and Africa and Latin America. Today, original equipment represents 61% of our sales mix and the aftermarket 39%. This further highlights the opportunity that we have to develop and grow our aftermarket parts, service, repair and replacement business. Like our engineered product offering, Flowserve's industrial product offering can trace its roots back centuries.
This slide highlights just a few of our attractive industrial products. On the left, you see an example of our overhung process pump line. This again is the Mark III product line. These pumps represent the largest individual product category for industrial and are the products most recognized by our customers. As I said, this product line presents a significant growth opportunity given planned enhancements, improving operational performance and distribution expansion potential.
In the center, you can see an example of our SiHe dry vacuum product. This is our Boost product. Our vacuum system products in both liquid ring and dry vacuum formats are used in a wide variety of emerging industrial applications and present very interesting growth opportunities. We have terrific geographic expansion opportunities with this product line, given the opportunity to leverage what we've already done successfully in Europe, elsewhere around the world. On the right, you see an example of our sealess pump offering.
Sealess pumps are one of the fastest growing product categories in our portfolio. Here we have a very effective design, an exceptional operating model, a distribution friendly product and market leading lead times. With our industrial portfolio, we have prioritized a number of what we're calling design to value initiatives, consistent with our Flowserve 2.0 agenda. These products are designed to better align product features within market requirements and reduce overall product costs and lead times. The early progress with our initiatives are revealing significant opportunities.
Between 2011 and the trailing 12 months ended Q3 2018, the reported financial performance of our industrial product division remained relatively stable at the top line. It's important to note, however, that in 2015, we added approximately $300,000,000 of revenue when we acquired the CEHEE business. This helped to offset declines in our core business through the industrial recession. On the bottom line, we experienced a dramatic reduction in performance in 'sixteen and 'seventeen. This performance decline was stabilized in the second half of twenty seventeen and year to date in 2018, we have delivered 3 consecutive quarters of expanding operating margins.
I would attribute the disproportionate operating income decline versus revenue to general impacts associated with the challenging market conditions we are facing and 3 more unique factors. The first is that one of our facilities was significantly leveraged to the upstream oil and gas markets. And when those markets collapsed, that location was materially impacted given its high fixed cost structure. A second unique factor is that we had self inflected wounds associated with poorly executed realignment programs, affecting multiple sites, primarily in Europe. We also had some failures associated with the integration of CE, primarily related to the acceptance of large scale, highly complex, high risk process systems orders.
To put things into perspective, imagine that you're a plant manager and it's 2016, you're sitting in Europe and you're at one of the sites receiving transferred products from 1 or possibly more of the sites that are scheduled for consolidation. You're trying to manage your own business and receive in some cases multiple product lines from multiple facilities. Let's say you start with $100,000,000 business that's project oriented and you have a decent aftermarket mix. While with the industrial recession, core volume, MRO spending, aftermarket spending, pricing are dropping rapidly, becoming incredibly competitive in the period following the oil price drops.
As you're on
the receiving end of multiple product line moves from multiple facilities, mostly from make to order and assemble to order plants and those product lines will be coming to your facility and you're more geared towards something that might be more engineered to order, which requires a completely different operational cadence, a different clock speed and you might say a whole different organizational DNA around faster, shorter cycle product activities. The moves aren't going well. They're not well planned. They're not well executed. And there's very high turnover in terms of employees and resources at both the send and the receiving sites, some directed by Flowserve, some self selection.
You run a different ERP system than each of the send sites that you're receiving products from. And you essentially have pallets of material showing up at your dock with a couple of handwritten notes on them, without clear work instructions, bills of material, routings, supply chain relationships that you need to establish, ERP support, because the send site is being consolidated and roles are being eliminated. So you get these transferred products. Some of the vendors that you have start failing, because they're also suffering from the effects of the industrial recession. Some going out of business, and you're trying to qualify new vendors for the products that you're localizing or for those that you need to replace and you're having difficulty with this.
You're in crisis mode and your entire business begins to suffer. You fall behind on all activities and are scrambling. You need to invest inefficiently to solve these problems and you get stuck in a vicious cycle. So now multiply this by several sites that were in send and receive mode during this period, in addition to the responsibilities associated with integrating the CE acquisition, and then compound that with bench strength limitations in the business. Okay.
So now let's come back to today. Following significant leadership changes, resource adjustments, completed consolidation projects, divestitures and the implementation of significant process disciplines and controls consistent with our Flowserve 2.0 framework, we have been able to stabilize the business and have delivered 3 consecutive quarters of expanding operating margins. And we remain on track to exit 2018 with mid to high single digit operating margins. And we remain confident in our expectation that this business should operate in the mid teens from an operating margins perspective. Today, after very thoughtful consideration, we've announced the consolidation of our Industrial Product division and our Engineered Product division into a new organization we're calling the Flowserve Pumps division.
This is a logical next step in the evolution of our enterprise and one that will dramatically simplify our pump structure, enable the use of more consistent and standardized processes and allow us to better leverage our global talent pool. As significant as the internal synergies associated with this decision are, this is a change that is driven by our focus on aligning more seamlessly with our customers. This approach will enable a more streamlined and common front to back end alignment and improved engagement with our customers. When customers across our end markets order pumps from Flowserve, they don't differentiate between what we had separated internally as engineered and industrial product divisions. Most order products from both organizations for their projects, and our internal misalignment with this approach added complexity, waste, risk at points of handoffs and increased time to our quote to cash cycle.
Our organizational separation had also trapped valuable resources that could otherwise be leveraged to help improve performance across the organization. In every case, our organizational separation has resulted in duplicative efforts, excessive handoffs, unnecessary consolidation points, increased project management requirements, decreased resource leverage, as well as execution and organizational alignment challenges. There are also product line rationalization, operational resources and organizational synergies that we can more readily access through the combined engineered and industrial divisions. Moving forward will be a simpler, faster, more consistent and easier to do business with organization as we more closely align our business with our customers. Ultimately, this approach will position us to more effectively serve the $70,000,000,000 global pumps market.
Our pump strategy builds directly from the rationale for our divisional consolidation and is very much focused on having the best people, driving the right processes and technology, ensuring our best alignment with customer needs, and resulting in targeted and consistently improving financial performance. As indicated, this process starts with people. And in 2018, we made significant progress in ensuring that we have the right people in the right roles. We'll continue with this approach in the future. We're also working to advance simplified, streamlined and standardized processes that are focused on best leveraging our operational resources and improving performance in and across all areas of the business.
We're investing in marketing, technology and our product management capabilities to ensure that we have accurate and comprehensive understanding of the market needs as well as highly effective and prioritized rationalization, standardization, product development and design to value initiative plans for our product lines. Operationally, we've made considerable progress in addressing structural costs as well as discrete operational challenges, and we're seeing targeted year over year improvements across multiple sites. This journey is not complete, however, and we're now leveraging the best talent in our consolidated organization to accelerate progress. In partnership with Flowserve's enterprise wide functional leaders, we're also driving several initiatives that will ensure sustainable improvements across all areas of our newly formed division. In closing, I'm really thrilled to be here at Flowserve at this important and critical time in its evolution.
We have fantastic opportunities across the enterprise and in the markets. And I'm committed to partnering with my colleagues and my team and our teams across the enterprise to realize our full potential. Thank you for your attention this morning. I'll now turn the presentation over to my colleague, Kirk Wilson.
Good morning, everyone.
My name is Kirk Wilson, and I lead our aftermarket services in our Sealed business. I've been with Flowserve for 31 years, and prior to my current role, I've served the company in a number of different engineering, commercial and operational roles. From a professional perspective, I've grown up within the company and have learned our business from the bottom up. From a personal perspective, I enjoy working across the Flowserve organization to improve our capabilities, better serve our customers and grow our business. I'm excited to be here today and provide some context around our aftermarket services and our Sealed businesses.
The Hingley integrated refining complex is another example of putting Flowserve's purpose into action. This is one of the largest refining complexes in China providing fuels, plastics and other chemicals to meet the needs of to meet the economic and social needs of Northern China. This facility was designed with a focus on safety, low emissions and energy efficiency. Flowserve is proud to be a key supplier of the flow control technologies for this project, supplying nearly 200 pumps and over 2,000 1,000 actuators in a variety of applications. This project is currently being commissioned in preparation for commercial production in 20 19.
As the site begins commercial operations, Flowserve is well positioned to provide ongoing services and support safe, reliable operations through our local network of QRC and support resources. Flowserve is well positioned to support projects like Hingley from a final investment, engineering, procurement and construction and startup standpoint. Our services team and project group work closely together to ensure a seamless transition as our equipment arrives on-site for installation, commissioning and start up. Today, our services team is on-site performing these activities in collaboration with the Hingley commissioning team. Our global operating structure is a competitive strength for Flowserve.
We are locally focused through our unmatched network of quick response centers and regionally supported with hub operations, engineering and commercial capabilities. Through this global structure, we are well positioned to deploy our capabilities and expertise to effectively service our customers at a local level, delivering consistent performance and quality. Today, Flowserve is well positioned locally to support our customers' maintenance, repair and operational needs and deliver our comprehensive portfolio of services and solutions for pumps, valves and seals. We continue to invest in our footprint and global operating models for further expansion and to improve our capabilities. And aftermarket is a critical work stream under our Flowserve 2.0 transformation.
I'll address this further in a few slides. Our growing installed base of pump valve and seal products is the cornerstone of our aftermarket franchise. This chart is created from our global installation database, which is used to match our shipped product records with our customer sites at which our equipment is installed. As you can see, we have over 5,000,000 products installed and operating around the world, and we continue to populate and improve the sophistication of this data. John mentioned earlier that a typical control valve will create an aftermarket opportunity of 4x its original price over its operating life.
By comparison, a typical process pump has an aftermarket opportunity of 6x its original price. Scott talked earlier about the power of the pure play. Through our installed base and local support capabilities, Flowserve has access to many of the companies who operate flow control equipment around the world. Since most our customers have multiple Flowserve products installed within the same site, we are uniquely positioned to better serve our customer and earn a broader share of their maintenance spend. On this slide, I'd like to highlight some of our core services offerings.
Flowserve offers a broad portfolio of aftermarket service offerings. This allows us to tailor our services approach to address the unique needs of each customer. While Flowserve offers an integrated solution for our customers, we segment our offering so that we can apply product management methodologies to enable focused capability development and profitable growth. We have broad capabilities to repair and upgrade both Flowserve and other OEMs equipment. This work can be done either within our QRCs or by providing work on-site at the customer's location.
Depending on the criticality of the equipment, the required turnaround time can be days to hours. Most major repairs involve pulling the equipment from its installed location and taking it to the customer's maintenance department for coordination of the repair work order. Let's use a typical pump repair as an example. Our customers' maintenance team will send the pump to a Flowserve QRC, where we will then infect the equipment and develop a recommended work scope for the repair. We may rework some parts, we may replace others.
Once we have aligned with the customer on the repair scope and schedule, customer site for reinstallation and startup. Responsiveness, quality and cost competitiveness are key drivers of this repair business. Our upgrade capabilities are focused on improving reliability, safety and operating performance of the equipment. These upgrades can be performed during the repair process or as part of a capital improvement project. Typically, Flowserve identifies the opportunity, designs the solution and partners with our customers to develop the economic justification for the investment.
We also offer an extensive and growing variety of long term services contracts. Some agreements are partnerships for on-site services or outsourced maintenances. Others are incentive based contracts where we apply technology and our engineering expertise to improve uptime and reliability. Our CLLCA program is an example. These are multi year performance contracts where Flowserve has an engineer embedded at the customer site and integrated into their daily activities.
Flowserve has a contractual commitment to manage all repair work orders, drive reliability improvements and achieve operational performance metrics. Turning to our parts. Our parts business is the biggest segment of our aftermarket. We ship thousands of orders each day through our hub operations and network of QRCs. Some parts and components are shipped from inventory and others are manufactured on a just in time basis.
Service, speed and responsiveness are the key to success because our objective is to get the parts delivered in sufficient time to support the maintenance cycle of the specific work order. Now turning to our Seal business, which is a big part of my responsibility. This is a well performing and profitable business with significant opportunities for growth. The difference between our seal business compared to our pump and valves business is that the mechanical seal market is highly concentrated with only a handful of suppliers. Flowserve is one of the top players in this space.
Also 80% of our seal revenues are aftermarket related. For customers with process plants, maintenance spend on seals is a focus area due to the number of seals they have installed and the environmental implications associated with seal failures. Seals are normally one of the first items within a flow control system requiring replacement or repair. This provides Flowserve with a 1st mover advantage to secure pump and other rotating equipment services. Our seal installed base is created when Flowserve supplies new seals to rotating equipment OEM customers.
Those seals are incorporated into the OEM's product and then shipped to our end user customers for installation and operation. So our ability to grow new installed base for seals is dependent on our ability to offer competitive seals and dependable service to our OEM customers. This is a strategic focus area for my team. Turning to our product portfolio. Flowserve offers a full range of seals and support systems for all types of rotating equipment applications.
We continue to invest in technologies to support new engineered ceiling applications and design the value initiatives to round out our industrial products portfolio. Steel support systems are critical to maintain an optimal environment at the seal faces and prevent leakage to the atmosphere. We manufacture a broad range of support systems varying from very simple to very complex. Additionally, we offer seals and systems for high temperature, high speed gas applications. We work very closely with the compressor OEMs to apply our technology in new applications and through retrofits and upgrades of existing applications.
Now turning to our strategy. We have a comprehensive strategy that leverages our strengths and positions Flowserve for sustainable profitable growth. Our overarching themes of this strategy can be summarized in 3 elements. First, leverage our installed base and global footprint to grow Flowserve's share of our customers' MRO spend. 2nd, aggressively grow our on-site service offerings and capabilities.
3rd, grow new installations of Flowserve pump seals and valves, which sets up our future aftermarket services opportunities with new customers. From a process and technology standpoint, we continue to refine and globally deploy our best in class aftermarket operating models. We are also investing in technologies that will enable a differentiated services approach. We continually work to improve our responsiveness and deliver professional customer experience, the best in the industry. And operationally, we continue to invest in our QRC capabilities and footprint to provide best in class services for pumps, valves and seals.
Much of this strategy is accelerated through our Flowserve 2.0 transformation under the aftermarket work stream. Scott will share some specific examples of this later in our program. I'm very encouraged by the progress that we made and excited by our many opportunities to further improve and grow this business. Now I'd like to hand the program over to Erik Van Gemeren.
Number of roles at that time ranging from engineering, R and D, product management, marketing, channel development, strategy, M and A, that kind of thing. More recently, I was the 1st Vice President of Marketing and Technology reporting directly to Scott. But about 8 months ago, he asked me to take on my current role leading the Flowserve 2.0 transformation, which he'll talk a little bit about in a few minutes. For the next 30 minutes, I thought we'd give you a little bit of a preview as to some of the technologies that we're working on to further our differentiation in the flow control industry. I'd like to begin by another example of our purpose statement in action.
In this particular case, this is the Tuas Reverse Osmosis Desalination Unit in the country of Singapore, providing potable fresh water to that growing population. Flowserve not only provided a number of the pumps that are used in this facility, but also provided a proprietary isobaric work exchanger in the process, which actually scavenges waste energy from the effluent and reapplies it to the inlet side, that allows us to use a much, much smaller set of pumps on the inlet. Now that does a couple of things. For the customer, it reduces their capital investment, which they need. But secondly, and most importantly, it dramatically reduces the amount of electricity required to run that plant.
And that's one of the single largest input factors that affects their profitability. So it substantially improved their margins. But also from an environmental perspective, it also significantly reduces the amount of greenhouse gas emissions since this particular desalination unit is fed by a fossil powered plant just down the road. So this gives you an example of how Flowserve is using technology, not only to differentiate ourselves from the competition, but also to materially improve the performance and profitability of our customers' businesses. Now we serve a lot of different customers in a lot of different end markets.
I'm going to talk about refining here today just as an example. And I think our refinery customers are very similar to a number of our others and they face a number of big constraints. As refineries grow from 100,000 barrels a day to 400,000 barrels today to even more than 1,000,000 barrels per day, the availability of capital to fund those investments becomes much more difficult to come by. Also with crack spreads as low as they are, the profitability of these individual plants is stressed, so every penny counts to them. And finally, because of the new millennial characteristics and the global mobility of labor, the ability to attract and retain experienced talent in that organization also continues to be a real challenge.
So as a result, there's a couple of things that come out from them that they need. 1st, they need equipment that is lighter, faster and runs with a higher temperatures and pressures to support the larger scale of these plants. Next, they need equipment that delivers much higher process efficiency, reduced energy consumption and allows them to increase the yield of the plant for the same or less raw material inputs. Next, they need equipment that runs for a longer time and has a shorter cycle time when it does need to be maintained or repaired. These last two points are, I think, really important and are worth spending a little bit more time on.
If you think about a refinery, in some of our customers, a single hour of downtime can be worth as much as $1,000,000 lost in EBITDA. Therefore, they need to know that, that machinery is going to be able to run for extended period of time between planned maintenance. And when it does need to be maintained, it needs to be turned around really quickly. And we're going to be talking a little bit about the types of technologies that FlowServer is working on to help solve problems like that. So as you can imagine, the complexity of these challenges requires more than just a single strategy to design and technology development.
In fact, Flowserve pursues a very broad portfolio of technologies that allow us to solve these kinds of problems. For example, if you look at some of our pumps, in order to deliver higher and higher levels of hydraulic efficiency, we use complex computational fluid dynamics, 3 d modeling, multi physics analysis and other kinds of tools that have allowed us to do things like develop a biased wedge design to our impellers, which not only improves the efficiency of the pump, but also reduces cavitation. Another great example is you look at our mechanical seals. In the compressor business, in order to be able to provide high speed mechanical seals with very low leakage, our research allowed us to develop a new type of laser micromachining where we use high energy lasers to ablate the surface and create features that are less than 1one hundredth the diameter of a human hair. And these are not things that come about easily.
They require a portfolio of R and D investments over the course of many years. So Flowserve is very committed to exploiting this technology and improving our product portfolio, and there's a number of changes that we've undertaken in the recent past to help us get there. First, as Scott mentioned in his introduction, we created what is now called the Marketing and Technology Organization that brought together a number of the key stakeholders to make sure we were proactively developing technologies that were focused on solving customer problems. Next, we brought together some technical resources in what we call our Global Technology and Engineering Centers, not only to help us reduce cost, but also to help us protect our intellectual property and better leverage the combined know how and experience that's represented in our organization. And then last and certainly not least, we have been much more proactive in increasing our investment in fundamental research and development as well as gap filling product development.
And you can really see that in our product road map. This is just a very high level sample of some of the things that we've been working on. In the past, under what we call Flowserve 1.0, we had a much more reactive or opportunistic approach to product development with limited resources that tended to focus more on incremental gap fillers and product line extensions, that kind of thing. With the advent of Flowserve 2.0, we've taken a much more proactive approach to managing our product portfolio, getting a better balance between incremental product line extensions as well as investments in breakthrough technologies. Going forward, our intention is to continue to increase our investment in product and technology to make sure that we are continuing to differentiate our product portfolio as well as earn the right to grow with our customers through long term relationships.
One of the case studies that we'd like to show with you today is the industrial Internet of Things. And now that's a hot buzzword that hear in a lot of places. But actually, this is something that Flowserve has been working on for more than 20 years, long before there was a term coined the industrial Internet of Things. But a lot of people fail to appreciate what really makes solutions work. You hear a lot of noise in the media about wireless transmitters and wireless sensors that give you more data.
But our experience over the past 20 years has shown that to be successful in this space requires a lot more than that kind of thing. So it's tough to understand the life that an operator lives in a machinery control room, in a refinery. So let me try and give you a metaphor to help understand this. Imagine you're traveling on business in a company car in a part of the country you're not familiar with late at night and suddenly the check engine light comes on in your dashboard. Now you don't know what the problem is.
You don't know what the potential consequences of that problem could be, but you have to make a decision. Do I pull over on the side of the road and do something? Or do I ignore it and just carry on? Now, the probability that pulling over on the side of the road is actually going to help you fix the problem is very, very small. In fact, it will probably waste a bunch of time, you'll probably incur some expense trying to call AAA and it could be late for perhaps an important business meeting.
Yet, a lot of people, without knowing what that consequence or implication could be, will choose to follow that path. It's no different for an operator sitting in a refinery. What they need is they don't need an alarm that says temperature is high or pressure is out of spec. What they need to know is what's the root cause that's creating this problem and what does it mean to me and how much time do I have before I need to make a decision? So that's what we've really tried to do here.
So Flowserve has developed a solution, a portfolio of solutions called Intelligent Performance Solutions or IPS for short. Now IPS is different. It's not about simply putting more and more wireless transmitters, pressure transmitters, etcetera, into the process. It's about taking that data and performing analytics on it that help identify the true root cause and give actionable insight to the end user and what do I do about it. And that's really us leveraging our 228 years of collective experience, not just in the design and fabrication of these units, but also maintaining and operating it through some of the services that Kirk talks about.
So our focus is really embedding that intellectual property into the diagnostics, the smarts, if you will, to really differentiate it. We take an approach of partnering with a number of technology providers to provide all that backbone because a lot of that backbone has now just become a commodity. So the real differentiator is the intellectual property and the value for us is it helps us pull through more repairs, service and parts work through our aftermarket franchise
that Kirk leads. Again, we've been
working on this for a while. Some of the enabling technologies have been around a long time. Recent advances in areas of artificial intelligence like unsupervised machine learning have given us a big boost and a big step forward and allowed us to move into a new generation of solutions that are really different. We are now in a piloting mode. We have 8 customers that are piloting various implementations of the technology and real operating services and are giving us the opportunity to really validate it and get objective customer driven data and acceptance to make sure that what we're delivering really does make distant future.
But rather than just talk about it and show you a bunch of pretty pictures, I thought it might be a little bit more compelling if we actually gave you a running demonstration. So on the stage next to me, as a number of the folks have talked about, is a Flowserve industrial pump. It's one of the smallest that we make, but it does really represent the workhorse of a lot of the continuous process industries sold under the Durco brand. This is a single stage overhung pump, variable speed unit running through, in this case, a simple single phase AC motor. Now we have in this a Flowserve mechanical seal, a little hard to see.
The mechanical seal is what separates the process fluid from the external environment and therefore keeping the nasty stuff inside the flow loop and keeping the rest of us safe. Now the in this particular example, we're just simply pumping water through a closed loop circuit. We are using 2 Flowserve 3 piece vol Ls that we sell out of our Worcester brand with electric actuators that we sell under our Limitorque brand. Now the whole thing is instrumented with a number of pressure transmitters, temperature transmitters, vibration transducers, a flow meter, etcetera. And there's a data collection system on board, which is capturing all this data in real time, cleaning it, normalizing it, etcetera, and before sending it to the cloud where we actually perform our analytics.
If we quickly go and take a look at the user interface that an operator would see, and for those of you on the WebEx, I apologize that we're not able to stream live the user interface, so you'll have to continue to look at the last slide for the next couple of minutes. Here you will see what an operator would actually get to see sitting in a machinery control room. You see a simple illustration of the pump unit. You'll see the actual operating parameters in terms of speed, temperature, pressure, vibration, etcetera, everything an engineer would want to know. Now in this particular case, you'll notice that a couple of these are showing an anomaly.
Here again, it's a great example of my earlier metaphor. In this case, the anomaly is raised because this unit is designed to sit on a concrete floor that absorbs vibration, and we're sitting on a suspended deck here, and the pump is actually picking up those vibrations, and it's saying something is not right within the normal operating parameters. Again, not actually a complication the end user needs to worry about. So notice the pump doesn't say, I have got a problem. However, there are a number of common ways that simple units like this can begin to experience problems.
1 of the most common is simply fouling or blocking or obstructions in the inlet to the pump, which can reduce the available flow of material into the pump. We're actually going to simulate that right now and by simply closing down on the suction valve to simulate what would happen if there was detritus or solid material that had begun to block the inlet of the pump. Now this is also a really great example of what it's like in a process industry plant. If I look at the pump, I can see no outward sign that something is wrong. Now for the purposes of our demonstration, we're using clear plastic pipes, so you can actually see cavitation and bubbles flowing through the system and you can hear a change in the noise.
But by looking at the pump, I would not be able to tell that something is wrong. Now over on the remote display, of course, you would see a bunch of anomalies that pressure is off, temperature is off, vibration levels are high. And in prior generation, like some competing alternatives, for example, you could even interrogate the asset a little bit more and try and see what is going on with the vibration. But just like in our metaphor, that doesn't really tell me what the problem is. I don't really know what to do with that, okay?
There are probably no less than a dozen different reasons why the pump could be exhibiting these behaviors. What our solution does differently by using our intellectual property to really understand this device, notice at the bottom, it tells us that this pump is cavitating. It doesn't say it thinks it, it knows it. And it has identified that unique failure mode from all the other potential failure modes that this pump could be identifying. The other thing that it immediately does is it tells you what is the implication.
So it says, in this case, if you were to leave this unit operating in this condition, the impeller is going to fail in 5 days. So now the operator has tangible information that they can use to actually make a decision. They can also begin to understand what that is what the consequence is on their broader system. So if we were to look in the upper left hand corner, look at our BEP, we can see that the pump is actually only operating at 51% of its designated efficiency. And if we were to click on that, you'd be able to see more detail about how it's operating off of its curve.
So you can imagine how now this begins to give operators much better information on what to do. But we don't want to stop it there. Remember, the idea is for Flowserve having that partnership with them to be able to connect with them and provide them better services. So down in the bottom right hand corner, there's an opportunity where the operator could click on a link that would tell them here are the parts that you need to order from Flowserve, here's the service procedure that needs to be performed and we can actually schedule the visit of a service technician out to the site with the required parts in hand and the required tools to be able to perform that maintenance on the spot, okay? So it goes a long way to helping our customers understand how to keep their plant running longer.
So if we just fix this failure mode here for just a quick second, I'd like to demonstrate an extra part of the technology that helps our end users, our maintainers, who sometimes have a lot less experience than they had many years ago, understand how to interface with the unit. So as I mentioned before, there's no local displays here that show what pressures and temperatures are like. So by giving them access to a simple tool that they probably already carry in their pocket, an iPhone or an iPad, for example, we give them the ability to interact with the unit and get a level of information that they wouldn't otherwise have access to Using a technology called augmented reality, we allow them through the camera, you can see that that's an actual live image of the unit here, to superimpose the actual operating conditions right on the unit. And in this particular case, the technician would be able to see that, hey, cavitation is incurring and I could have an impeller failure in the next 5 days. Now because I, as a technician, might not have as much experience as that I had before, perhaps I want some advice on what I have to do about this.
So in this very simple example, we would even walk them through doing, for example, a bearing replacement. So if I click on bearing replacement here, you can see that the AI actually blows out the units. And again, we've given a very
different perspective of
the asset and see how exactly different perspective of the asset and see how exactly it goes together. And I would essentially have the benefit and the wisdom of somebody who's done this several times, and it's right here in my pocket without actually having to have that experience myself. Furthermore, if I needed more help, I could give an exploded view of the asset with instructions on how to actually take it apart and interrogate it from different angles and be able to see exactly what the innards of this device are to, again, give me the ability to perform and to deliver the capabilities of a service and repair technician with far more years of experience than I actually have. So what you see through this demonstration is the deliberate and judicious use of technology to allow our customers to keep their plants running longer, avoid unnecessary downtime, dramatically reduce the amount of time required to maintain a product and provide a direct connection with Flowserve so that it is very easy for them to order the parts and service that they need when they need it and give us a greater share of that business throughout the aftermarket life cycle of this product.
So I hope you've enjoyed the brief demonstration. I believe next up on the agenda is a quick break, but I'll turn it back over to Jay Roos. Thanks very much for your time.
Thanks, Eric, and great demonstration. As he indicated, we are at the halfway point. And so we're going to take a quick 15 minute break. We'd ask everybody to be back in their seats at 10:15. And for the folks online, just hang on and we'll be back live in about 15 minutes.
Thank you.
Like we got most people back, if not all, so that's good. Hopefully, you enjoyed our technology demonstration with IPS. Just a couple of things on that. I would say it is very exciting technology, and it is very much a great business opportunity for us. But we are still in the early days of getting this to commercialization.
So as Eric showed, we've got 8 pilots, and we're working very closely with our customers to make sure that the pilots are performing and executing how we want them to. And then we've got to switch the mindset to taking pilots into commercialization. So what I'd say is we're talking to a lot of our customers and the adoption of how this is going to work and how it goes on-site is definitely taking slower than I would anticipated. And so they all understand the need. They like the technology.
Getting installed and up and running is proving to take much longer than I would have expected. So it's good stuff. And what I would say is Flowserve has been doing this for a long time, and we continue to build on our technology. We continue to build on the platform that we have. And I think we're doing really well from a competitive standpoint to be positioned nicely for when this thing does take off and goes forward.
All right. So I'm going to switch now to the transformation. And so I talked a lot about stabilize in my first section. And now you would suggest that we're pretty much through that and really want to get into the meat of this the whole purpose of why we're doing the Investor Day here is how we're going about our transformation with Flowserve 2.0. I'll start with the or the beginning of the transformation really was a self assessment on our business.
And so we launched the self assessment at the end of 2017. We did this with a combination of internal resources and third party to make that it was objective and real. And essentially, it was a self evaluation or due diligence on our company. And we did that because we wanted to understand where the opportunities were and how we start to think about putting the game plan in place. And so we all had ideas of where value could be created, but getting that true self assessment was really the starting line to launching the true transformation.
And then the next step, once we did the assessment and said, okay, there are opportunities, there's lots of value that we can create at Flowserve, The next step was how do we go forward to capitalize on the opportunity. We had a couple of different choices here, right? We could just continue business as normal and say functional leaders take on these different projects, business leaders take on these, or we could do something fundamentally different to drive the change. And so obviously, we've launched Flowserve 2.0, and we decided to go with this fundamentally different approach. And the reason we did that is we needed a catalyst or an accelerant to drive the change.
And so, Flowserve over the last couple of years had launched different programs different initiatives that it kind of sputtered out or stalled or it didn't really work. And for me, committing to a transformation really meant that. We were going to commit, we were going to go all in, and we were going to make sure that we follow through. And so that's why we've now launched the full scale transformation program. And in April, we started so it started in April of this year with a fully designated team.
And I'm going to go through a lot more details as I go through the slides. But that team started in April, and we're currently executing the first wave of projects, as you can see on the screen here. And I expect that this team will continue through the early part of 2020 as a designated team, and then we'll disband the team and start to embed initiatives back into what I call normal business or functions and platforms. And so that's the intent right now. It's about a 2 year program.
We really want to define all of the opportunities in the scope. We want to have the dedicated team executing and creating that momentum for change. And then after that 2 year mark, we just manually move into normal operations. And then finally, I've got the optimized phase here at the end of transformation. And at the end of my slides, I'll go into kind of what I mean with optimize.
All right. So this is the framework for our transformation. And it starts at the bottom here with organizational health. And organizational health is focusing on the culture at Flowserve. And part of Stabilize was creating purpose and core values, And it really was about starting to change the culture and the health and improve the health at Flowserve.
But health employee engagement morale is absolutely instrumental to any change effort. And again, I'll touch on this a little bit later, but it is foundational to what we're trying to do. In addition, IT infrastructure, IT enablers, understanding the data that's resident within Flowserve and how to use that is also foundational or instrumental to our transformation effort. That's why they're at the bottom, right. So these are the foundational elements.
The middle is the Flowserve 2.0 transformation program. Again, I will go into great detail by work stream on that. And the top starts to outline our aspirations across 3 different categories. And so we want to grow our business, we want to expand our margins and we want to improve our capital efficiency at Flowserve. So now that's at the top, that's our aspiration.
And in Lee's presentation, he'll go forward and talk about specific targets in each of these three goal areas on the top of the screen. Okay. Then we've organized the Flowserve 2.0 transformation into 6 different work streams. And so I'll just start at the top, operations, we've got commercial, we've got the growth work stream, we have an aftermarket work stream, cost structure work stream, and then finally, we've got a work stream on working capital. And in the coming slides, I'm going to go through each one of these, and I'll provide more details and provide a few case studies of where we are on progress and how we're driving change in each of the 6 work streams.
All right. So this slide is very busy. It's meant to be busy. It's an infographic that represents what's going on in the Flowserve. I'm not really going to go through the details of it, but I want to show the magnitude and the scope of our transformation.
So just a couple of nuggets, right? Today, we have 58 designated associates working full time in the transformation team. We've done 62 different town hall meetings in the last 9 months around the world educating and communicating to our associates what is the change, why are we doing it and what does it mean for them at the local area. The portfolio within Flowserve 2.0 is balanced between growth, so 58% growth and 42% on cost reduction. And at the bottom, you can see that we were at the progress to date, which is just under 20% of transformational activities.
And the next thing you see here is that like you expect from any large or complex program, we are actively and professionally managing Flowserve 2.0. We have proper governance. We have stage gate and formal gate reviews. We have biweekly steering committees, which my entire team participates in and I do it every other week. We do deep dives on critical initiatives and we have common and transparent metrics and KPIs.
The other thing I want to add is that this is a dynamic and living process. And so every other week, we go through where we are. We talk about the different projects. We talk about value capture and it changed. And so last month, we had to pull down our total prize because we knew those were there are projects in there that just weren't going to work.
But at the same time, we're constantly adding to the opportunity set to say if we do these things, this is how we could drive value or drive down working capital. And so it is a live and dynamic program. And then our transformation effort and probably the best way to put this into an analogy is it's very similar to managing a large company integration after an acquisition, which is essentially what we're now doing at Flowserve, right? We're integrating a lot of the legacy efforts in the local facilities into a much more enterprise mindset and enterprise focused approach for the long run. Okay.
So I'm going to go work stream
by work stream. We're going
to start with operations. Our ultimate goal in operations is to significantly improve our ability to deliver quality products to our customers, right. I've talked about problems in past due backlog before. We've talked about realignment problems before. This work stream is focused around doing things significantly better within the manufacturing side.
And so we're going to do this over 3 key areas. So one is manufacturing productivity driven by lean principles. 2 is the centralization of our supply chain. And then 3 is the creation of a Flowserve manufacturing operating system, which includes playbooks or standard procedures around planning, inventory and other key manufacturing processes. So let's go into 2 case studies for operations.
The first case study is a single facility. It's in John's business in the valve business around electric actuation. This facility has seen enormous growth in 2018 and we've struggled to keep up with the current demands. The initiative started in Q3 with a comprehensive assessment over multiple manufacturing processes. We then developed an action plan based on lean principles and we've now begun to implement changes systemically at the facility.
So the goal of this pilot is 50% reduction in non value added labor content. So this is shop floor workers that are there. We're paying them and they're not creating value on getting an electric actuator from the beginning of the process out to the end of the process. There's lots of different reasons why that happens. It's not a good thing, but we're committed to driving that down by 50%.
We also believe we can take out the cost of poor quality. So this is scrap or rework, again, non value added activities. We believe we can drive that down by 20%. And then as a result of this, we also believe that our lead time or our throughput time in the plant will be reduced by 40%. So essentially, this is creating capacity without having to invest in equipment or additional roof line for this particular product line.
So we recently launched this program now at 3 other facilities and we believe there's similar type results at all three locations. All right. So let me go to another case study and this is on our supply chain. So again, still in the operations work stream. This is supply chain and it's specifically around castings.
And so castings is our number 2 commodity or number 2 spin within our supply chain. And for those that don't know what a casting is, a casting is a result of pouring molten steel or into molten alloy into a pattern to create a shape. And so for us, this would be a valve body or a pump body, right. So you can see the pump body here is a casting. Every one of our pumps and all of our valves start with a casting.
Some of them are forged, but the majority of them come from casting. So again, this is the 2nd largest commodity within Flowserve. So Flowserve today has 700 different foundries or casting providers and over half of these support only one location within Flowserve, right. So that is not ideal. It's way too many and you'd like to get some leverage here.
In the past, any procurement specialist within Flowserve could purchase from any foundry around the world, right? So they had the local decision rights to go out and purchase whatever they wanted. While it gave our local operations a lot of flexibility, what it didn't do was provide us at Flowserve in aggregate the ability to leverage the scale and drive pricing down and improve systemically performance from our supply base. So we needed better pricing and better service and we weren't able to get it due to our fragmentation. We now have a centralized we've now centralized the management of commodity and we're moving from reactive to proactive managed spin.
This means having long term contracts with approved vendors who can meet our quality standards, our lead time requirements and commit to the competitive pricing that we need in today's environment. So our goal for this program is 20% reduction in the number of suppliers, 20% reduction in our lead times and 20% I'm sorry, and 14% reduction in the direct or the material cost of castings worldwide. While we've made tremendous progress on this initiative, it does take time to make systemic changes in your supply chain. And I expect to start to see significant benefits from this in the back half of twenty nineteen and into 2020 as we realign our supply chain and capitalize on the work that we're doing here. All right.
So the second work stream, we're going to talk about commercial work stream. This is about getting the most out of our selling resources and it's about cost reduction and improving our selling effectiveness. One opportunity for FlowServe is to improve our overall quotation cycle time and our responsiveness to customers. We're doing this by creating regional quoting hubs to quote the entire Flowserve operating sorry, the entire Flowserve portfolio. So this is creating a quoting hub in Europe that has access to all of our products, has all the information and data needed to quote that and is able to quote it quick and accurate.
We're standing those up around the world. Streamlining the quotation process and eliminating bureaucracy is another aspect and implementing automation tools that can configure price and quote. So this is software or configuration software that allows us to very quickly quote our process rather than do it very manually. Unfortunately, today only a very small portion of our business utilizes the automated CPQ tools, And that's primarily in John's business in valves. We have a big opportunity in pumps, but we also have an opportunity in valves to continue to make progress here.
So this initiative is moving forward. We're making good progress in the work stream as we rethink the intersection between our selling resources and our customers. All right. So the next work stream I want to talk about is growth. There are 2 important initiatives within this work stream.
The first is what we call strike zone. And strike zone is about capturing greater market share in target markets that are attractive to Flowserve, right? So it's basically participating in markets where we think we can be more competitive and get better margins. It's a comprehensive review of industries, applications, geographies and an understanding of Flowserve product offering and defining where the opportunities are to participate. It's a proactive approach.
It's not reactive. And it's where again seeking out where we want to grow the business. The second initiative within growth is pricing optimization. And that's about using data analytics to eliminate pricing inefficiency in defining opportunities to raise prices. So let me give you a case study on our strike zone for North American pipeline market.
This program was focused on increasing our presence in the North American midstream pipeline business. So everybody knows, right, midstream U. S. Market is doing really well right now as we're reconnecting and replumbing the oil and natural gas back into the places where they need to be delivered. So we launched this initiative in the Q2 of this year.
And over the last couple of years, Flowserve had migrated away from this market for various reasons. So the first step was to define the attractiveness of the market against our other competing markets. We did this again by a comprehensive review of our products, the review of our products, the market dynamics, the manufacturability of the products and then the internal processes. Step 2 was to redesign both our pipeline valve and our pipeline pump to be more competitive for the U. S.
Market. Step 3 was to retool our processes to ensure that we can be responsive in a very short cycle business. So this is a very fast, very responsive market. And if you're not Kirk was saying a little bit of this earlier, if you're not providing quotes quickly and if you don't have your lead times where they need to be, then you don't have an opportunity to retool our processes around quoting, terms and conditions and manufacturing processes and supply chain to make sure that we capture the lead time that we needed. And so I'm pleased to share the results of this already.
We've done we've had 50% reduction in our quotation time. We've reduced our total cycle time by 15%. We've won $12,000,000 of orders to date. So that's year to date orders that we've booked. And we currently have another $18,000,000 outstanding for North American pipeline work.
And so we fully expect to continue to grow market share here and be a participant in the North American Midstream space. Next, I'm going to switch to our aftermarket work stream. Earlier, we talked about the importance of aftermarket to the Flowserve and is very much our intention to aggressively grow this business. The work stream is focused on how we manage the business and committing to growth in aftermarket. And there are 3 main initiatives within the work stream.
The first is about getting more business from our existing and an extensive installed base. If you remember, Kirk showed the red dot map there of our installed base. And so what we want to do is leverage the 181 QRCs that we have around the world to get more out of that installed base. We call that initiative commercial intensity and I'll do a case study on what we're doing with commercial intensity. 2nd is to increase our offering for aftermarket services in migrating more to reliability based solutions.
So you saw the IPS demonstration, that's a reliability based solution. We want to be able to add that into our portfolio, commercialize that and have that as an offering within Flowserve. And then finally, we are implementing standard operating models for our global QRC network to drive standardization and to better gain leverage from our global network that we have in place. All right. So let's do a case study on commercial intensity programs.
So this is the first one that we launched. It's in South Texas and we started it this summer. And commercial intensity, again, is about getting more business from the existing installed base that is right there within a radius of that facility and it's about improving our capture rate. So we started with a data driven assessment on what is the installed base, what's the current capture rate and where are the opportunities. Next, we implemented a new management system to provide better management and control.
So one example of a new management system is that we're now measuring our cycle time to do what we call DCIQ. And DCIQ is when we get a pump or a valve out of the field, it's disassemble, clean, inspect and quote. And so it's basically the disposition of that pump. We look at it. We say, here's what's wrong.
We turn a quote back to our customers and then they make a decision on whether or not they want us to proceed with that repair. Well, if we don't quote them what needs to be done and the cost, then by definition, we're never going to get the job to repair. And so we weren't tracking this metric. And what we found, we're in a lot of cases that we are missing the opportunity to actually conduct the repair because we are so long on our responsiveness in getting back to our customers. So we just weren't quoting fast enough.
We also empowered We've seen a 30% increase in customer facing time. So this is our sales engineers freeing up their time to spend with our customers understanding their needs and starting to capture their business, right. If we don't have that face time, you're not going to get the opportunities to participate in their business. We've got a 25% improvement in responsiveness. So that's that DCIQ cycle time.
We've cut that down by now by 20% or 25% and we're now we've improved our increased share of spend at the location by 20%. So in a very short period of time, that business is up 20 percent with the exact same installed base. So we think this is a pretty exciting program. We've now launched pilots in Europe, in Asia, doing the learnings from the pilot in South Texas. And we're in the middle of rolling this out now across all of the North American sites within the QRC network.
Let's go to the cost stream initiatives. So this is really 2 different or the work stream is cost structure and there's 2 different initiatives within the work stream. The first initiative is to reduce total cost of goods sold through product rationalization and design to value. So this is very much focused on product cost reduction, not supply chain because we've got that in operations, but more on the design side and the rationalization of our product offerings. And I'll give a detailed example here on the next slide.
And then the second is about a reduction in our overhead G and A cost at the Flowserve enterprise level. So I'll talk a little bit about the G and A reduction. We're going to do this through 3 things. 1 is reducing the complexity of Flowserve. So we've started that process.
So we've done a lot of things to reduce complexity. 2nd is implementing shared services globally, primarily in finance, but across other functions as well. And what I would say is we're in the early phases of the implementing shared services. And so that's a big program, Lee is the champion of this and we're grinding through it, but we're making good progress on moving toward a shared service environment. And then finally, driving business simplification, which will ultimately allow us to get cost out of the business.
Okay. So let's talk about product cost reduction in a design to value case study. So this is an industrial pump. So it's in the pumps business under David. It's a one of many product families within IPD.
So this is one product offering out of many within the Industrial Products Group. And what really designed to value is about bringing together the right functions within your organization and relooking everything about the product and looking from all the way through design through execution and driving cost out of the product. But it's also about listening to our customers and getting that true voice of customer. So we're not designing in features that the customer is not going to pay a premium for. So a lot of engineering companies like to design these in.
Unfortunately, you're not getting paid for them. And so part of the process is making sure we have the right offering at the right time and we're getting paid for what we deliver. So this requires a significant cross functional team. It requires sales, product management, engineering, supply chain, manufacturing, quality folks, aftermarkets involved, right, because we want to think about the serviceability and the reliability of the product and then the logistics side of moving products around. So through a defined and rigorous process using the latest available technology, the team has been able to achieve outstanding results.
And so we've got on this specific product line, 57% reduction in product variance. So this is a reduction in or product rationalization, which is reducing the complexity of that different product line. We've also reduced the number of parts significantly by 43%. So the number of parts in this product has now gone down by 43%, and that is simplifying the design dramatically. And then finally, we're driving down the fully landed cost of the product by 42%.
So this is one example, right? The question is how do you extrapolate this across the Flowserve portfolio? What I would say is a lot of the products within Flowserve have not been relooked for many, many years. And so we showed kind of 200 years of history. Not going to say they haven't been looked at in 200 years, but there is significant effort here across the portfolio.
I'd say there's probably more effort or there's more opportunities in the pump side than in the valve side, but John has designed to value opportunities within his business, and we've got an aggressive program to move this forward. The other knock on benefits of design to value are around quality and delivery. So if you do this right, inherently you're improving your quality because you've made it simpler and you factored in the operating or the manufacturing considerations. And then also, you're going to be able to deliver it much faster because the product is simpler and easier to put together. So those are 2 other benefits that we should capture as we go through this.
So again, this is our first product through a very rigorous process, but we do expect to see similar results as we launch this process across the organization. So we're currently building out the capability and the resources to make this a core competency at Flowserve. Okay. So next I want to talk about working capital. This is one that is moving slower than I would like.
I'll just start with that. But it's all about dramatically improving all elements of working capital. This has been an opportunity for Flowserve for a very long time and we fully intend to capitalize on it through the Flowserve 2.0 transformation. So we are systematically attacking this through a rigorous program here and we've got designated teams on all three aspects of working capital. So inventory reduction team, our receivables reduction team, and then we've got folks focused on the payable side as well.
So we're making progress, but again, it's been slow. And let me I'll go through and let me give you the case study here on inventory. So we'll go into inventory in great detail. So the goal of this initiative is to significantly improve our inventory velocity at Flowserve. The initiative is focused around manufacturing planning, right?
And so if you can't plan your work, then by definition, it's really, really hard to drive inventory down. So most, if not all of our actions are really around the planning function at Flowserve. We've got a handful of locations that plan their business very well, but it is limited to a handful. And planning has never been a strong competency at Flowserve. We've now invested in the central planning team.
We're developing planning processes, and we're conducting global training on basics of manufacturing planning. And so this is the Apex program, right? So it sounds a little elementary, but these are things good manufacturing companies do, and we've got to get substantially better in this area. So we're implementing sales and operational planning across every business unit in Flowserve. We've launched material planning workshops at 24 of our largest sites.
And we have also reset the planning system parameters at each of those 24 locations to follow best practice for material management and inventory planning. Additionally, we've significantly improved our visibility to track and monitor inventory at every location within Flowserve. We launched this at the beginning of this year and we're just now starting to see the benefits of a lot of hard work. Our goals for this program is a 9% reduction in raw material inventory, a 10% reduction in slow moving or OSME and then a 20% improvement in inventory turns or inventory velocity. So again, this program is taking longer than I want.
We've got designated team, but we're just now starting to see good progress on inventory reduction. Okay. So that was the 6 work streams I'm going to transition to 2 fundamental elements here, is organizational health and IT systems. So on organizational health, this again is foundational to the health and culture of Flowserve. And as you saw in our core values, our first core value is people.
And I fundamentally believe there's a high correlation between employee engagement and organizational health and business results, right? So health translates and correlates to results. And so we are committing to driving organizational health throughout the transformation process. We're doing this through enhanced communication with our associates, transparent business performance metrics, more definition and clarity around roles and responsibilities. And then if you go back to my pyramid that I showed, driving strategic clarity, right.
And so strategic clarity is aligning purpose, core values, strategy down to objectives and initiatives at the local level. Change management is not easy and it's certainly not easy while we're transforming new organization. And we have embedded these health practices in every single work stream and everything that we're doing within the Flowserve 2.0 transformation. So again, in these biweekly steering committees, we talk about health every single time that we meet. It's incredibly important to our change management effort.
So let me give you some examples and some data points on what's happening here. So I'm pleased to share that we've made really good progress since I've been here on driving employee engagement. These results are measured from an employee engagement survey with a baseline in the Q4 of 2017, so right before I got the flow through. From the end of 2017, we have improved employee pride by 300 basis points, employee optimism by 1500 basis points and employee engagement by 500 basis points. We've made progress here and I'm happy to report that our employees are committed to the journey and engaged in the transformation, right?
So when you think about why transformation fails, the number one reason is that you don't have your employees and your associates behind you in driving that change. And so what this tells us is, we've really reached out, we're making an effort to bring them along and you can see the results that people are committed to the change and committed to what we're doing at Flowserve. So super important aspect of what we're doing. All right. On IT, I want to talk about the importance of business systems and business data.
So in order to have a strong operating system, you must have good data integrity and robust business systems. We're working very hard at Flowserve to embed enterprise wide systems to enable our transformation and run the company better than it has been in the past. We're focused on 4 critical areas on enterprise wide systems. The one is product lifecycle management, but this is your engineering system or your engineering business systems. And so essentially what that is, is we're embedding our part numbers, our designs, our engineering drawings in a common platform that's standard that any location around the world can look up a part or a drawing and be able to pull it into their facility.
Not having the ability to do that makes our organization very cumbersome and it's very hard to leverage the scale that we have. So this is an important enabler. We've been working on this for 2 years and we've got another 2 years to go before we're on a common PLM system worldwide. The second one is customer relationship management or CRM. So this is the front end of the business, right?
This is mapping opportunities, sales contacts and putting your demand planning into 1 single system worldwide. I am pleased to announce that in the 4th quarter, we went live for the first time on a CRM system at Flowserve called Flowforce. So we are now live. We've got the same system across the whole platform. Our valve guys can see opportunities from the pumps guys.
Our aftermarket team can find out where we're installing product and we've got the transparency and the visibility now to run the front end of our business. Now what I would say is we're a month in, so there's a learning curve and there's an adoption period. And so we're working through that, but I'm very confident that our team has set up the appropriate system to provide the visibility that we need. And then the last one is enterprise resource planning. And so as most of the folks that have covered Flowserve for a long time, they know this, we have a lot of disparate systems within Flowserve.
And so we're working hard to come up with a strategy on how do we start to bring these systems together. And at this point, we haven't made the decision of whether we need to go to a single ERP system globally. That would be ideal, but it costs a lot of money and takes a lot of time and quite frankly, it's a big disruption. Or do we go down a path where we centralize to 2 or 3 different platforms and put something over the top of it in the cloud that still allows us to get the benefits of a single system? And so we've got a great IT team working through the system.
We are working through the analysis. And what I will say though is we've launched pilots already. And when you saw the platform presidents talk about their business, you saw assemble to order, make to order and engineer to order. What we've done is launched pilots on an enterprise resource planning system across each of those three ways that we deliver products. And we're moving forward with these pilots to say in an ideal world, this is the ERP construct that we would have to manufacture and deliver our products.
So we're making good progress on that, but we'll ultimately have to make a decision on how do we get into a more seamless and harmonious enterprise resource planning. And then underpinning all of these initiatives is the imperative of master data governance and business process architecture. So master data and understanding your data, so this is part numbers, it's employee data, it's all of that data. We've got to do it full serve. We've got to do a much better job of managing that data and then harvesting that data into useful business intelligence that we can use to make good business decisions.
All right. So that is
the end of the transformation section. I'm going to turn it over to Lee, who will go through our financials and the financial targets around Flowserve 2.0.
Thanks, Scott, and good morning, everyone. I am Lee Eckert. I have been with Flowserve for 14 months, now as Senior Vice President and Chief Financial Officer. I'm excited to be at Flowserve and here today. As you've heard, there are significant opportunities to grow and improve the fundamentals of our business.
We aspire to make Flowserve sufficiently nimble to perform well at any point in the cycle. Towards the end of my presentation, I will present our aspirations of Flowserve's future performance. But before I present the future, I would like to spend some time talking about the past. From 2010 to 2014, Flowserve grew EPS from $2.29 a share to $3.72 a share, an increase of 62%. The market conditions were generally favorable and Flowserve was able to deliver.
From 2015 to 2017, however, the environment changed dramatically with deep cuts on our customers' capital investment and maintenance spend. As you saw earlier, with a weak top line, Flowserve was not able to respond quickly to the rapid decline in our markets. Profits fell disproportionately relative to the decline in revenue. EPS went from $3.72 a share in 2014 to $1.36 a share last year. The company did not have the flexible cost structure, the enterprise wide processes and ability to timely respond to the new reality.
As we begin to stabilize the company in 2017 with our renewed focus on people, process and systems, Flowserve has started down the path to recovery, and it has become apparent in our financials. In 2018, we have delivered stronger bookings, growing revenue and expanding margins. I'd like to spend the next few minutes giving an update on 2018 performance. In 2018, we have generated a recovery in the top line. Bookings are up 4% on a trailing 12 month basis versus 2017.
Aftermarket bookings have been particularly strong, and we experienced growth in every course of market except Power. For the first time since 2014, we have delivered consecutive quarters with over $1,000,000,000 in bookings. We've also expected we also expect bookings to remain solid in the 4th quarter based on where we are today. On a trailing 12 month basis, sales were up 6% versus 2017 on better backlog conversion and improved manufacturing execution. Importantly, profitability has also improved in 2018, reflecting the benefits of stabilization.
On a trailing 12 month basis, both adjusted operating income and adjusted EPS have improved substantially year over year, driven by better operational execution, sales leverage and the improved quality of our backlog. On a year over year basis, adjusted operating income and EPS are up 14% 23%, respectively. We have driven this improving performance despite some headwinds, including inflation and compensation. Operating cash flow is a significant area of focus. While we delivered strong cash flow performance in the second and third quarters, year to date, we remain below our expectations due to a weak Q1.
Like last year, however, we expect to again deliver strong operating cash flow in the 4th quarter. Working capital, however, remains an area of opportunity for Flowserve, which I will discuss in more detail in the next slide. As you can see, adjusted net leverage is stable at 2.1x, supported by our strong cash position of over $500,000,000 as of September 2018. As I just mentioned, working capital performance is a major area of opportunity for Flowserve. Our challenges in this area include multiple accounting systems, lack of enterprise wide processes and organizational inconsistency, which have created headwinds in driving significant improvement in the short term.
For example, we currently invoice electronically less than 20% of the time. We do not have a centralized billing and collection department, just to name a few. In AR, we are putting the people and processes in place to drive sustainable improvement. However, for the reasons I mentioned, it will take some time to achieve our aspiration of building a systemic process and solution. In the meantime, we are spending significant time and energy driving a reduction in our AR balances with weekly cash calls, investigating and resolving AR balances and driving greater organizational accountability.
Year over year, we've been able to reduce DSO by 6 days. In inventory, we are making progress, but as Scott said, it's taking longer than we anticipated. Fundamentally, Flowserve has not invested in the processes or systems to support our manufacturing planning. We have now established our team and developed new processes, which are being rolled out under Flowserve 2.0. Key examples of this is the business unit sales and operations planning, shop floor production planning and inventory management.
We are investing heavily in new processes and training to significantly improve manufacturing planning at Flowserve. This investment in planning will allow Flowserve to reduce total inventory and accelerate our inventory velocity. As previously highlighted, working capital is one of 6 key Flowserve 2.0 work streams. We fully expect to drive significant value by improving our performance in this area. Flowserve has a solid balance sheet with significant liquidity.
As I mentioned earlier, we have over $500,000,000 of cash on hand and available capacity under our revolver of $420,000,000 Our debt cost is competitive with an average interest rate of 2.7 percent, of $1,400,000,000 of notes, which do not mature until 20222023. Our untapped revolving credit facility, however, is expected to be refinanced next year. We have strong relationships with our banking partners, which we value, so we fully expect the renewal to go well. In summary, our capital structure is highlighted by significant liquidity, low cost debt and no major near term maturities. Historically, Flowserve has been able to flex its capital deployment priorities to adjust to our changing market conditions.
From 2010 2014, Closers spent, on average, $605,000,000 a year on capital expenditures, acquisitions and returning capital to shareholders. In 2018, we expect to spend approximately $285,000,000 on realignment and transformation, capital expenditures and dividends. Our focus is always on maximizing shareholder returns and maintaining our financial flexibility. Today, management's primary focus is executing the Flowserve 2.0 agenda. We believe there is significant value that we can create by integrating and enhancing the assets we currently own.
The flow control industry, however, is highly fragmented and M and A opportunities do arise from time to time. We would consider an acquisition for the right asset under the following conditions: it would have to be financially attractive the integration would need to be seamless we would need to maintain our financial flexibility going forward and of course, any transaction would need to drive superior shareholder returns. Overall, we are committed to driving ROIC improvement and we'll allocate capital accordingly. In our Q3 earnings release in November, we revised our 2018 financial guidance. Today, I am reiterating that guidance and I would like to highlight at the midpoint of our 2018 adjusted EPS would be up approximately 25% versus the prior year.
While we will provide full year 2019 guidance in our February earnings release, I would like to highlight the financial metrics that we intend to deliver longer term. As Scott discussed, Flowserve 2.0 will be a key enabler in driving growth, margin expansion and capital efficiency in the business. Thus, I will highlight how Flowserve 2.0 will drive revenue, profitability, free cash flow and ROIC improvements by the year 2022. Regarding the top line. Flowserve 2.0 will enable us to grow revenues by 2 percent above market levels through 2022.
Our portfolio initiatives around growth, aftermarket, pricing and targeting attractive markets is expected to drive this growth. The South Texas pilot is an example that we can leverage throughout our aftermarket business to help grow above the market rate. In terms of profitability, we expect that our Flowserve 2.0 strategy will result in operating margins of 15% to 17% by 2022, a significant improvement from levels today. Our portfolio initiatives around engineering, manufacturing excellence, supply chain, SG and A, along with volume leverage will help to drive this expected increase. Reducing both non value added labor and the cost of poor quality in our electric actuation business, together with reducing cost of our castings, are examples of the many opportunities that Flowserve has to systematically drive costs out of the business.
We expect that driving year over year productivity in our business will become a core competence of Flowserve. Flowserve's free cash flow conversion has been a point of emphasis on our earnings calls. Flowserve 2.0 is intended to enable us to convert 100% of our net income. Our portfolio initiatives around AR, inventory and payables, along with leveraging enterprise wide investments, will support this conversion of our net income. Scott shared how we're using data and rigorous demand planning to take raw materials down, reduce our slow moving inventory and deliver an overall improvement in inventory turns.
Our expectation is that we will drive 20% improvement in inventory turns by 2022. In addition, there are
a number of initiatives to improve our
digital, so by standardizing our terms, invoicing daily, leveraging our enterprise dispute systems, improve the quality of our customer documentation and having a global collections team, just to name a few. ROIC is a key metric that the Flowserve team is focused on. We've been educating our 17,000 associates to its importance in driving shareholder value. We've aligned our long term incentive plans around improving it. By 2022, Flowserve 2.0 is structured to enable us to increase our ROIC to the 15% to 20% range.
As I wrap up my section, we believe the new operating model, Flowserve 2.0, along with continued disciplined capital deployment, will drive superior shareholder value. We aspire to make Flowserve an enterprise that delivers year over year improvement in earnings, cash flow and returns,
while having the ability to prosper in the various business cycles.
The momentum we are building in 2018 gives me the confidence that we will deliver on our aspirations going forward. Our targets are aggressive but achievable. Will now turn the stage back to Scott for his closing remarks. Thank you for your time.
All right. So we have a few closing remarks before we open it up for questions. You've heard from myself with the company overview, the platforms gave a little bit about their businesses and what they're doing. We did a technology deep dive and a spotlight on one of our innovative technologies with reliability based solutions. We've given financial targets.
We've gone to a deep understanding of our full serve transformation. And we're now at wrap up in Q and A. So let me just hit a couple of slides as a reminder of what we've done. So this is the very first slide in the investment highlights. We've got a distinguished history and a broad product portfolio that's recognized within the industry and it's our customers.
We're very proud of that heritage and that legacy and we fully expect to build and capitalize upon that. We do believe that despite the volatility here recently with commodity pricing, we do believe that the end markets are recovering after multiple years of under investing in capital. I give one example here that I meant to give earlier, but when you think about LNG facilities, LNG has been under invested in many, many years. An LNG facility takes about 5 to 6 years to go from concept through execution. And we're just now starting to see movement again in critical LNG projects that are providing natural gas to Europe and Asia that desperately need it.
So we do feel that capital spending will increase over the next couple of years. Obviously, there's signs and signals in the current environment that provide a slight pause. We also talked a lot about the aftermarket business, right. And so we have a significant installed base. Kirk showed the map there.
It is a designated work stream within the Flowserve transformation about how do we better manage that business and how do we start to grow that business aggressively. We're talking great detail about Flowserve 2.0, which will ultimately unlock the full potential and allow us to capitalize in our opportunities at any phase within the market. And then on the financials, while we're doing reasonably well now, we know we have meaningful opportunity for improvement. So this was the sequence of the phasing that I highlighted in the journey at Flowserve, right? So stabilized phase, we're essentially done.
We've got the team on board. We've done the blocking and tackling with purpose statement, core values. We've got strategy in place. We've got alignment and we're doing good things here. Transformation, the robust program across 6 work streams that's going to allow us to transform our business and move to a more optimized state.
Eric used the car analogy earlier, so I will stick with that. But the way I see Flowserve 2.0 is we've got our company driving down the highway in a car. We're going pick a speed 50 miles an hour or 60 miles an hour, But at the same time, we're overhauling the engine while we're driving down the road. And so that's what it feels like to me on a daily basis that you're trying to go quarter over quarter, but at the same time, we're fixing this engine as we go, so we can have a performance level that's substantially better than how we're operating and performing today. And so you can imagine our daily challenges of running the business, delivering quarters, but also trying to fundamentally transform the way that we operate and conduct our business.
So that's all happening in the Flowserve 2.0 under the 6 different work streams. And then finally, we want to get to a place of optimize, and I'll touch on that in my last slide. So I don't want to leave today without stressing and emphasizing our commitment to technology. And so Eric walked through with a couple of slides that we've done the demonstration. But at the end of the day, we're a product and service company.
And when we move into the optimized phase, we've got to be able to differentiate through technology. So you will see us start to talk about technology more than we've ever talked about within Flowserve before excuse me, with who ever talked about before. And you'll start to see us increase our investment within R and D and technology across the product portfolio and the offering. So here is the framework again for Flowserve 2.0. We're committed to our people or the organizational health.
We're also committed to the IT enablers and the IT infrastructure that give us the foundation to leverage the scale and drive more optimized process within Flowserve. So this has got to happen. It's long overdue at Flowserve. We're basically getting back up to a standard that a lot of other companies are at today. The transformation is in the middle, 6 work streams.
We've touched on that. I won't go through that again. And then really the top is about the aspiration, right. We fully commit to growing the company regardless of the market environment. We want to expand our margins and we need to drive capital efficiency as we go forward.
Here's the framework that Lee put out, right. So 2% revenue growth above the industry growth, 100% free cash flow conversion or more, operating margins moving up to the 15% to 17% and then ROIC at the 15% to 20% range. And as Lee talked about, ROIC is now a critical metric with my leadership team and the leaders of Foserv. We had to do a little bit of an education over the last 12 months on what this is and why it's so important to us. But our team is starting to get it and we're starting to behave in manners and fashions that start to really move the needle and focus on returning returns to our or returning invested capital or return on invested capital and returns to our shareholders.
Now all of this is really good on the left side of the page. But in addition to that, and I think this is the difference from where Flowserve was historically and where we're trying to take it, we want to have that financial performance, right? We want to continue to drive down the road at speeds faster than we're driving today, but we also need the new engine to do right. So we're creating this operating system. We're constructing this Flowserve 2.0 operating model.
We're developing a flexible cost structure that should work in any environment and allow us to flex up and down with the cycles that we participate in. And then we're creating a powerful platform for growth, right? So this is both growth organically and growth inorganically. But if we do something inorganically, we need to be able to integrate and plug it into something. And that's why this operating system and focusing on the operating model is so important in Flowserve.
And then finally, here's the optimized state, right. So it always starts with people. We need engaged associates that are empowered and doing good things around the world. It's a focus on our customers, right? We're serving them, being partners with our customers and building the long term trust based relationships that will be that will bring value to Flowserve.
It's a differentiated product and services through technology, right. So this is the commitment to technology. We're truly differentiating offering with the peer group. And then it's the operating model, right. So having this standard operating model that really is enterprise wide and not inherent at a local facility.
And then finally, it's around the cost structure and delivering superior financial performance. So I'm excited about what we're doing here at Flowserve. We've stabilized. We're now in the process of transforming. We're making good progress on that.
We're still in early days, but we're starting to put the plan in place that shows that we can absolutely get to the optimized state. So with that, Jay, we'll open it up to Q and A. We've got a lot of hands already. I'm going to step down here.
Hello? Yes, I got it. A lot of good detail here today, really appreciate it and a lot of specifics about the roadmap, a lot of good work and we like seeing the depth of management here today as well. So if I look at all of the projections and targets that you've given, the most important one from our perspective is cash flow, because that was the has been the one quality of earnings metrics that Flowserve has lagged. And in your presentation, Scott, as well as Lee's, you emphasized that you're it's coming
the working capital is coming slower.
Yes.
So we hear that. And maybe help us bridge the target of plus 100 percent is which you should be able to do, but that's not until 2022. How do you what's the path you get there? Is it all back end loaded? And just set the expectations if you could, please.
Yes.
No, I'll give a little bit of color and then Lee can jump in here. But no, we're committed to the 100 percent free cash flow conversion or more. We put 2022 there for all of those metrics. Some will happen a little bit earlier and then some are more on the 22. On the cash flow side, the working capital is the single biggest thing, right?
And so we've got to drive working capital down. It's inventories and receivables are the 2 big areas. What I would say is we're starting to make significant progress on that here in the back half of twenty eighteen, And we think we can continue that progress into 2019. But it's not going to be Santa Claus coming to town here. All right.
Santa Claus bringing free cash flow to full serve, yes. But what we want is it's not going to be a step change difference in 2019, right? This is more of a continual process and a progression on improving those metrics. Lee, you want to add anything on
the free cash flow?
Can you hear me?
Can you hear
me now? I think you nailed it, Scott. I mean, we're not saying necessarily wait till 2022 to get 100% conversion, but there could be some points where you hit it, may drop a little bit and but the gradual increase towards that on a consistent basis. One of the things that Scott highlighted that will put some headwinds against that is the ERP strategy. So we're still evaluating that.
We've made some initial assumptions around that, but that can have a little bit of a drag on that conversion.
Okay. Good follow-up.
And just one quick follow-up, I think for Lee, but maybe Scott as well. On the M and A criteria, given the emphasis on ROIC today and the targets that you've set, I would have expected ROIC hurdle rate for acquisitions something in the order of like 10% by year 3 or something a bit more specific than saying it's got to be attractive and you got to be able to integrate it. So any hard numbers you can share?
No. What I would say is 2.0 has almost infinite returns compared to acquisitions. And as I said in my prepared remarks is our focus right now is Execute 2.0. It will be there isn't an acquisition that's going to have better returns than that. So right now, the focus is integrate, as Scott has talked about, integrate what we already bought effectively and get the value out of that and then be opportunistic if there's a transaction that fits a strategic need, has attractive accretion, has instead of just giving a 10% return time metric, it's got to be candidly compared to what other stuff we're looking at, it could be even better than that.
And so our focus is always on driving shareholder value. Right now, I think we have a lot of opportunities that, like I said, are assets we currently own.
Let's go
here. Just with respect to the 15% to 17% operating margin target, can you maybe dimension out how much of that is kind of core operating leverage versus discrete savings? I mean, if I look at kind of a typical incremental margin profile of the business, it seems like you need $100,000,000 of kind of extra cost savings as part of 2.0. Is it a finite number or is it just leverage higher? Maybe speak to that for a little bit.
Yes. Well, I would say, yes, we didn't just pick targets out of the air. And so we've built models around leverage and cost structure and all that. But we're not going to go into the specific details of how we built that. And so we're committed to driving 15% to the 15% to 17% growth there on operating margin.
But it's coming from a lot of different things, right? I gave a couple of examples in the different work streams of Flowserve 2.0. So there's a big product cost reduction element there. And so that's with the supply chain and also with design to value. But then there's also another manufacturing or product cost reduction on the productivity side or the manpower side of that.
And so those are 2 big levers that will improve our gross margin and ultimately drive up operating income. And then on the other one, we've got the cost reduction work stream, right, and that's around SG and A reduction as well. And so we know as we move to shared services and we start to lean out organization, we can continue to push that SG and A percentage of revenue down.
And then just on the revenue outgrowth profile, the 2%, I mean, one thing that didn't really come
up today or to
get a lot of airtime is the notion of, hey, there's businesses in here that aren't really 2.0 aspirant and more of a distraction than anything else and maybe they need to come out through an eightytwenty process. Is there a drag built into the model for things that are exited or as you consolidate ERPs that tends to weigh on growth in the short term. Is there any element of that that we should think about as part of 2.0?
That's a really good question, right? What I'd say is, thinking about our portfolio, We've done a number of divestitures over the last 2 years, right. We did 2 in the valve business. We did one recently in pumps. We're constantly going to look at what the portfolio is.
And we don't think if something doesn't make sense or doesn't fit into the long term growth, then we're going to actively move that out. We did not build any of that into the model, right? So our aspirations there do not include acquisitions or divestitures. But what I'd say is, we're constantly looking at that portfolio. We'll continue to make good decisions.
Where is pick 1 there, Mike. Here we go. We'll go to the back.
Thanks. We'll get to everybody here. Thanks, Scott. Just talking about that margin target again, the 15% to 17%, a lot of concern in the market right now that we're at the peak of the market, potentially going into a recession within that 5 year planning period. And so when you take a look at the percent of your projects that are growth versus cost, almost 60% are growth oriented.
And so how do you think about if we were to go into a recession over the next few years, how does that change the dynamic of where you're investing to drive stronger growth?
So I would just say, in our business, we've had in the last 4 years, we have been working through a cyclical downturn. And so we're very versed in this spot. And it doesn't change what we're trying to do with the Flowserve 2.0 and the different work streams, right. And what I'd say is, I'd just reiterate the installed base and focusing on the aftermarket, right. And so that's front and center in everything that we're doing.
And if things got even worse, it would just be our even further commitment to capitalizing on that installed base. And so we know we have opportunities. I spotlighted in the commercial intensity program. And so we know folks have to continue to spend money to maintain our products in order to keep these installations and these operations up and running. And so that would be a big shift.
If things get worse, we're going to be more and more focused on aftermarket.
And then maybe focusing maybe a question for Lee. So I didn't hear in the presentation what it's going to cost to achieve these programs. So are there any numbers around like realignment costs that we should expect over this planning period? Just any quantification that would be helpful.
Sure.
So I think the good news is we're not expecting a significant expenditure like the realignment. There will be capital spend that we've assumed that Scott highlighted around IT systems. Every year we do incur a certain amount of, let's say, severance associated with the implementation and that would be part of my annual guidance. Each year we'll assess what we're going to do, make sure all our programs have the right returns and that will be part of my 2019 guidance. So there's not a large number.
I think the good news is it's not as significant as been communicated in the past around realignment and it will be part of my annual guidance every year.
Okay. So let's go to the back here. Yes.
So I just want
to come back to the new pumps organization. So you did mention operational synergies associated with that effort. Could you maybe talk about or quantify what you see in kind of year 1, year 2 and then cost to achieve as well?
Yes. So I'll just touch briefly, but David here. We'll let him talk about his business. But we brought the 2 organizations together really to better service our customers and that was the number one factor there. Now the knock on benefits are some consolidation and some synergies, but really it's about providing better service and better aligning our products and the infrastructure there.
But David, do you want to talk about what you're doing, how you're bringing it together and what those opportunities are?
Sure, absolutely. Appreciate the chance to do so. We within the organization have had historically 2 organizations with EPD and IPD where customer orders would come in and they'd effectively get split. We've had one cut one face to the customer and that doesn't change in this model. We continue with that, but the internal workings of the company can be streamlined and simplified.
And so we had 2 organizations managing commercial operations, project management, the manufacturing execution, overlapping product designs in many cases, so there's product rationalization opportunity. And there are synergies that exist in the supply chain and the leverage across our total spend. So we do anticipate that there will be material opportunities and that is certainly an outcome will be an outcome to capture of that will be an outcome of our decision to bring these organizations together. But as Scott highlighted, our focus is clearly on our customers and on making sure that we're more seamlessly aligned with them and we are easier to do business with.
And then just a quick follow-up
Here, let me just I'll just be a little more specific on this, right. So we're bringing the teams together. We've already realized some synergy just on having single team reported to David rather than 2 different ones. And then I'd just say on consolidation of facilities, we will not be doing a major consolidation within pumps in 2019. But there will be opportunities as we start to integrate the products further and make better decisions about the manufacturing footprint.
And we'll see that next year.
And then just a follow-up, you talked about the IPD margins of mid teens over time. Are we going to have visibility into that business or through the combination, we really won't have understanding of where those might go over time. Yes.
The plan going forward is that we'll report a consolidated pumps platform. We'll provide some color about the different pieces that are moving around, but our intention is not to segment out IPD.
Okay, thanks.
Scott, can I just
add that rest assured that we will be focused on achieving those margins and that will be something we'll be looking at?
Yes. Here we go, Scott,
in the back.
Scott, I was hoping you can talk to us a little bit about sort of the next layer of management. So we saw all the change as the new people. But at the site level, how many of those folks are new and kind of need to be maybe retrained and reacclimated to something that they've never done before? How many of those folks are new?
Yes. So this is a great question, right. So the BIN strength and kind of the layer 3 and layer 4 are really important. It really is the heart of the customer interface and the operations and the execution. So what I would say is, we have made out changes.
It's not as much as what you've seen on my team. So I'd say it's relatively minor. But at the same time, a lot of the people that we've put in the new folks in are were inherent within Flowserve before. And what we've been focusing on is a training program rather than just completely changing out. So at that level, we really value the product experience and the experience working in the company.
What we need to do is get a more focus on the things that we want to do around manufacturing productivity, planning and things like that. And so we're still working through it. I'm not saying we're not changing folks out, as folks are coming out of the system. But overall, it's been less than certainly less than what you saw at my staff level.
Understood. Just a follow-up question, essentially on the aftermarket, which is half the company right now. And I guess I was hoping for a little bit more granularity on how you're going to grow those sales. In other words, we've had this installed base forever over 2,000,000 pumps. And the aftermarket has been resilient, but aftermarkets are resilient by nature.
So my question is really, how are we going to focus on growing half of this company? When you say leveraging the installed base, the prior team had an end user strategy that didn't seem to move the needle a lot. What are maybe some of the specific things that you're doing differently going forward to grow half of your company?
It's a great question. What I'd say is there's no silver bullet here, right? This is blocking and tackling, right? So let's go back to commercial intensity, the case study that I shared, the South Texas pilot. And so basically what that is, it's a single QRC, right, that's got 4 to 5 refineries, 2 petrochemical plants, and it's going in and fully assessing what is our entitlement, right?
So what pumps are there? What valves are there? How many seals and LCA agreements do we have? And what is the entitlement for Flowserve? And how do we grow that ambitiously?
And so we've essentially put in a whole new operating system. We've created new operating metrics. And we have a playbook now that's already seen 20% growth rate at that single pilot. Now I'm not sure if we're going to get 20% global growth across the aftermarket business. That's probably not within the realm of possibility.
But we know that by doing this and putting the right focus, the right playbook and changing that management system that we're going to see growth. And so we've done the pilot now in Europe, we've done it in Asia, and we're rolling it out across the Americas QRCs right now. So that's one. The second thing is, as Kirk highlighted, what I talked about was really looking at what the product offering is within aftermarket, right. So what services we provide, repairs, parts business, segmenting that and then really focused on the different business aspects of enhancing that with technology or new product offering and making sure that we've got the focus to continue to grow that business.
What I'd say is, I mean, we've talked we might not have as many slides as you want, Scott, but I mean, we talked about it in every single part of the presentation. And it is absolutely imperative that we've got to move to growth on this aftermarket business. And the other part of it, right, as we continue to ship every single year, we're shipping pumps, we're shipping valves. So by definition, our installed base goes up. So we
Just first question more of a definite, it's not even a question. So the operating margin that you're targeting, is it as reported or adjusted? It will be adjusted. Okay. So the broader question, as I think about your margin targets and I understand what you're doing is transformational in nature.
But if you look at your targets and if you assume any sort of operational leverage, what happened to all the fixed cost? Clearly, they were disruptive what was happening before, but at the same time, you have reduced the fixed costs, right? So do you ever capture these fixed costs and does that create some cushion in your numbers in terms of your 2022 target, right? Because it is a very substantial number. If I look at your target base call, I can assume, okay, let's just take whatever you were supposed to get, stick it in, stick in some up leverage and I will get to a very similar number.
So I think, yes, it's a good point, Andrew. And so what Andrew is talking about is for those who don't know is we did a pretty substantial realignment program, and we took a lot of facilities out over the last couple of years. And so by definition, you're taking fixed cost out. And so if the markets do come back up, we should get leverage on that. But what I'd say is and what we're very focused on is manufacturing productivity, and we haven't done that very well at Flowserve.
So if we can get the fixed cost leverage and additionally that labor productivity that we're driving, and I gave the case study of our electric actuation plant, then we start to get to the territory that's really good.
Good.
And the second question in terms of just on operational improvement, should we expect fairly linear improvement in margin from where we are right now to 2022?
You want targets year over year? No. So basically, with that I know you do, right? We're not going to provide that. We've given aspirational targets for 2022.
And the other probably key data point here is thinking about the transformation, right. So we're less than 20% through the activities in the transformation. And so as we progress that, then we're going to start to see a faster pickup on the operating margins. So I would say 'nineteen is probably a little slower than what some people are expecting. And then 2020 2021 start to see some pretty significant margin expansion.
Scott, maybe I can ask Andrew's question in a slightly different way. I think we're trying to figure out I think the core earnings power of the company to a certain extent. And so it doesn't seem like a coincidence that the guide for margin is 15% to 17%, because that's the peak margin you had in 2014 was 16%. So when I look at Flowserve 2.0, when I think about the pricing aspect over the last few years, is that the sort of price of doing business in 2018 to some extent, it's a more competitive environment? Or if I look at that revenue base in 2014, it was $4,900,000,000 If you're able to do that again, could you actually have higher margin than that 16%?
No, I think I mean, look, things are going to change as we move through this. Obviously, growth and the ability to leverage that growth is a huge enabler on margin expansion. When we put this together, right, we've got some assumptions in the back there. We're not assuming massive growth into 2022. And so what we believe that through the transformation, we can drive margin expansion at a moderate and muted growth rate, if you will.
And then back to what Andrew was saying, right, if we can get the growth and drive the labor productivity without having to add additional roofline and footprint, then we can really start to move margins in a better place.
And then I just wanted to ask a follow-up
on something you said. I thought you said that projects could slightly pause. I think that's what you said based on the volatility that's out there. What are your customers saying? Anything sort of new with the oil price drop that we've seen over last few months?
Yes.
So let's just go and we'll go through it. I haven't given a lot of color on the different end markets. For 'nineteen, we still feel pretty good, right. And so on the oil and gas side, there's activity in North America. We've got the Middle East and Russia on the land side all doing well.
But there's also got to be some capital expenditure back in to like the big developing countries with Nigeria, Brazil and others. And so I think some of that offshore and deepwater stuff does improve. Obviously, that's off a very low base though. And so I think oil and gas is a relatively good market for next year. On the refining side, we very much believe that capital continues to improve into 2019.
We're talking to a lot of our customers on that, and most, if not all, are planning to maintain or grow capital, right? And there's a couple of data points out there now as Chevron came out saying that they're going to spend more year over year and we're looking at others that are either flatter or slightly up. So we feel reasonably good within the oil and gas that we should see a moderate, it won't be great, but a moderate uptick there. I did touch a little bit on LNG, which will be an opportunity in 2019 for us. And so you can see several LNG So that's another kind of tick that says, when the EPC backlog is higher, then Flowserve is ultimately in a better position to grow their business because they're going to start to release orders.
And then on chemical, we still feel very good about chemical, right? And so chemical will we've got line of sight to projects. North America, Middle East and Asia Pacific is all growing. And we think capital investment improves even from 2018 into 2019. So we feel pretty good about that.
Again, the one downside would be power. And so we don't expect growth in power at all. In fact, we will probably decline year over year on power. And so we're out talking to our customers. We're trying to put together our budget, which I'll present to our Board next week.
But we feel reasonably optimistic about what the pipeline shows for different projects, both brownfield expansion and some greenfield activity for next year.
I won't ask you exactly what reasonably optimistic means.
Yes, I do give you a number. I'm going to show Roger that number next week.
Got it. But it sounds like it's growth plus 2, that's sort of the goal.
That's what we're trying to do, yes. Okay.
Hi. Maybe just first a quick housekeeping question. So thinking about that 100% free cash flow conversion, is that on the adjusted net income
or is that on a GAAP? I'm going to let Liam tie this out.
Lee, you want to tie that out? It's not adjusted.
Okay. And I guess as we're all kind of thinking about these OE orders that are ahead of us, maybe this is a question for the division heads as well. But can you talk about some of the new tools or what's changed as you're looking to quote those projects and maybe talk about linkage rates attaching service to all the OE you're doing and it probably varies by the application, but some high level about what's kind of changed around there?
Sure. So I'll give 3 things and then probably John, you're the best to jump in on kind of how we're tying sales together. But three things on linkages and what we're trying to do at Flowserve. So one is we put the CRM system in place, right. So for the first time now, we track and we have visibility on the front end and we're creating a pipeline.
And so before we had spreadsheets and we had a bunch of different communication, it was really hard for us to have a systemic way to track opportunities and the opportunity set of projects. And then second is we've created strategic account management. And so it was embedded in Flowserve before, but it was kind of, I would say, it wasn't as well done as I wanted. And really with strategic account management, so we'll take, pick, I'll just say, one of their large independents that we have a preferred relationship with. We've got now a designated team focused on serving that company and making sure that we're providing the resources from all of our organization to get the look to the different opportunities there.
And so between those two, it's allowing us to be much more proactive and allowing our sales force to point and go in the right direction. But John, do you want to talk about a little bit about the front end and how we're managing that and especially on how it relates to valves?
Yes. So on the valve side of the business, we've got about 250 sales guys that sell the entire product line. Okay. And in the past, that was more aligned to individual product groups. And so now we have a much better look when we get an opportunity developing that the management team can decide what is the best package that we put forward.
So in the past, we might have only targeted the control valves. Now we target the actuation, we target the quarter turn. And it's a much, much more team oriented sport than we had in the past. And it's really paying dividends. So we've with some of our new products, as they come to market and we commercialize them, it's they're all in adjacent space.
They're sitting right there. So the sales guy can not only sell a ball valve, but if there's gate valves on that opportunity. So all of that is really starting to click for us and that's come from retooling the outside sales force in the commercial ops business.
Great. Thanks, John. Other questions? Yes.
And when you were talking about 2.0, pages 6970, you had those two examples, supply chain and the operational excellence. What was the margin of those test cases? Like was that 500 basis points or was it 100 basis points? Like how did you do with them?
Yes. We're not going to disclose what the margin was at those locations. But what I'd say is, those both of those examples, so supply chain was castings worldwide, right. And we showed the ability to take 14% of cost out of that specific commodity, right. So again, that's the big metal, the gray part of that pump.
But we have a target 14% worldwide on casting cost reduction. And on the productivity side, that was one of John's facilities, it was electric actuation. And that's a really good product for us at really good margin.
I will leave it at that.
Okay. All right. Fair enough. And then the LNG projects, it looks like they might go next year. Can you quantify for us like what your content could be?
What's the opportunity size or what's the content on like a 2 1,000,000 ton per annum project?
Yes. I'm not going to go a number and a ratio here, but what I'd say is for us it's valves is the biggest opportunity. We do get pumps opportunities, But these are projects for us that could be tens of 1,000,000 of dollars, right. So in that range, we've done it before and we've announced publicly some of the different projects that we've won. But we've got a good position in the valve portfolio and we're working hard to make sure that we get pumps included in the LNG projects as well.
Okay.
And this is Goguet this is not specked in?
Yes. No, we are not specked in, but we have proprietary and good technology that fits nicely within the LNG space. Okay.
Okay. And just one follow-up.
It will be competitive, unfortunately.
Okay. You mentioned going back to the volatility question about oil prices. It sounds like the orders are fine, but you called out volatility around oil. Has there been is it more competitive pricing that we're looking at right now? Or is it projects that are potentially pushing because the price of oil is down?
Yes.
Well, I
have to
call it oil volatility because it collapsed here in the last few months. But no, I think it's gone down, right. And what I'd say is there's a very tight balance right now with the supply and demand within oil. And so I personally think that there's going to be a lot of volatility because there's about 1,000,000 barrels of spare capacity there. And depending on what happens with the geopolitical event or Libya coming offline, then there is going to be volatility.
But what I would say with oil pricing is that the bigger companies, right, the independents or the large independents and the integrated, they plan their business over a long period of time, right. And so back to the Chevron analogy saying that we're going to spend more next year than we did the year before. They're comfortable in the environment that we're in now, right. So we're at $60 a barrel on Brent and a lot of people are saying that that moves up to average about $65 But I think as long as it's not moving dramatically up and down, then they're going to continue to plan their work. And that's what's good for me, so or for Flowserve.
So we're more interested in stability and allowing operators to plan their business and commit their capital and move their programs forward than 55 versus 60 or 65. Yes, we feel pretty good that even with the recent volatility, folks are planning their business and they're continuing to progress things through. Where it falls apart a little bit would be small private equity backed or small independents that didn't hedge their production properly, and now they're cutting back or delaying some of that spending. Just curious, what do you
think the impact of design to value is on your aftermarket business over time? Obviously, design to value is something that makes a lot of sense to do for your customer. But is there an offset potentially on aftermarket?
Sure. So I'd say with design to value, what we're bringing there's 2 things. We're bringing in the aftermarket folks to make sure that we've got serviceability, right. So if you go back to Eric's kind of example where he had the iPad up and we showed things pulling apart into all that and highlighting the different parts, it's super important to make sure that we're thinking about that in the design to value thing. Then the other part, and I touched on this with the IT side, is PLM, right.
So if we're doing design to value properly, we're then loading the part numbers, the configurations and all of that data into our global PLM system. This is the engineering management system that then allows Kirk's team in aftermarket to quickly find part numbers or drawings on that pump and that configuration. And so, but I'd say the single biggest opportunity for us within that is the ability to get to parts and get to drawings very quickly, so we can turn around and remanufacture a part and get that back to the field. Kirk, do you want to add anything to that?
No, I'd just add that that's exactly it. The responsiveness is one of the biggest things that allows us to grow our share of our customers' spend. Everything that we do is in response to a maintenance cycle. And so if we're not able to respond on that cycle, it will go somewhere else. So having that ability and access to information plus being in local and proximity to the customer and working with them will enable that.
And then just cost reducing our products upfront allows us to be more competitive and get more installed base, to work off of.
Scott, maybe I missed it if you touched on it earlier, but it seemed like one of the opportunities that was historically late in the business was you have a lot of QRCs because on time delivery was slower and customers need it now. So part of that gap in the system was fulfilled at a local level. Is there a number as part of 2.0 or an ambition to take that number of QRCs down and is part of the cost savings or free cash conversion driven by that?
Yes. So the question was just QRCs and what's an optimal number and how do we think about that? So, Kirk, you're living this. Why don't you talk through it? Yes.
So like
a lot of our business, we look at our QRC footprint and our utilization on an ongoing basis. And that's a dynamic approach. We have QRCs that are coming into the portfolio and QRCs that we're rationalizing out of the portfolio. So our QRCs are located closely to our installed base and our customers that we're serving them the most closely. So an example of what we've done here recently is within the last 6 months, we've opened up a QRC in Brunei, leveraging between pumps, valves and seals.
It's one single QRC to support one of our largest customers in Brunei. And previously, we weren't rationalizing our QRC portfolio as much around pumps, valves and seals, whereas now we're going in together and providing a consistent service through the same footprint. An opportunity or an area that's an example where we've reduced our footprint is in the UAE. We've gone over the last 18 months from 4 QRCs in the UAE to 2. So we had pump, valve and seal QRCs taking up 4 different facilities.
We streamlined that down where now we have one facility in Dubai in the Jebel Ali Free Zone and one facility that's in Abu Dhabi. So we do this globally across all the markets and look at where we have opportunities and we will make sure that our footprint is positioned to be able to support
our customers in our installed base.
Well, I mean, it depends, right? And so we've taken 2 out this year. We've added 2 here. And so I think it's more about a repositioning. There's really no ideal number or optimal number.
But what Kirk implied, right, is that we've got the metrics now and we're tracking the productivity. And then with the commercial intensity program, we can quickly say how big is that prize and do we need to drive more do we need to do something different. And so I just say we're managing it and it really is going to depend on what's happening and the changes in the environment.
A big way to look at it is, as we have the opportunity to serve our customers more and add, we're not adding as much footprint because we're leveraging across pumps, valves and seals more than what we have in the past. Yes.
I think I mean, just I'd say just generally, right, as we drive productivity, both in manufacturing and in QRCs, net roof lines probably get smaller. The number might get bigger though, right. But we're not we don't need a bunch of capital to go plow into more QRCs is probably the best way to say it.
You mentioned educating the organization on returns
on invested capital. It's great to see
the improvements in employee engagement. Have you made any changes in incentives throughout the lower levels of the organization to kind of drive this alignment you're working towards?
Yes. No, for sure. So I think probably there are 2 big changes. We'll go lower level and I'll talk a little bit on management level. But on the incentive plans, 2 big changes.
So one was the customer change. And so we added on time delivery into everybody's incentive plan. And so that was a fundamental change. And I talked about past due backlog and customer responsiveness, and we've got to get more attention and focus around that. We've also we've had primary working include our sales force.
And so that change is happening in the works. Include our sales force. And so that change is happening in the works. And then we've got at the local level, we've also kind of a 2 step, right. So they get their local plan and then they get one level above that to make sure they're driving more of the enterprise mindset across that.
So they've got an NOI target. They've got working capital. They've got on time delivery. And then overall, it's a return based program. And then at my level in the executive team, it's similar in terms of those targets, but then the long term incentive plan is highly focused on return on invested capital.
And so that's the one and it's all about growing and return on invested capital. That's the program. It's got to be growth. All right. We got time for maybe 1 or 2 more.
Yes, go ahead. I just
want to
go back to the 2022 targets for a minute. You've got a slide in here that shows GDP growth about 3%. If you guys outperform that by 2%, you'd grow up 5%. And that would not only get you back to the same operating margin you had in 'fourteen, it'd be about the same revenue level. In the meantime, the company spent $400,000,000 to take out $230,000,000 of cost, a lot of which was supposed to be structural prior to you getting here.
You still need more cost reductions to get to that $15,000,000 to $17,000,000 I think Josh mentioned another $100,000,000 And so we've seen then that the structural part of the $230,000,000 cost reduction plus the $100,000,000 that you have to get out going forward to get to $15,000,000 to $17,000,000 is not being captured by Flowserve. Is there something else underlying the market here? Are products getting more commoditized? Are they able to earn just structurally lower margins? Are you assuming price doesn't come back?
Or just help us bridge that gap.
Yes. I think I mean, I don't think there's no silver bullet here or anything in the logic. What we're trying to do is continue to grow margins across the work streams and the activities that we showed. What I would say is, we're putting out the target that we feel reasonably comfortable that we can achieve regardless of the environment. And we're not going to stop if we get there faster, right.
We're going to continue to drive growth. You want to Lito, you want to hit some of the nuances on where that could come from? Sure.
So can you hear me? Okay. So let's talk about 2014 for a second. Back then, the dollar was roughly $135 versus euro. That's roughly worth, call it, dollars 600,000,000 of lost revenue and the profit associated with that just from 'fourteen till today.
So back then, the dollar was a lot obviously weaker and 60% of our business is outside of the U. S. So that's one of the challenges we have versus 'fourteen is basically lost $600,000,000 of revenue and the profit associated with that. Then going forward, the things that and you guys know this, but we have inflation and merit year over year. That's this ballpark that number between $75,000,000 $125,000,000 year over year.
I mean, me, like every other CFO, when we start coming out of the gates, we're already kind of in the hole versus where we ended. So my midpoint guidance was $1.70 that I presented earlier. I pretty much start the year $0.50 to $0.60 below that because I know there's going to be some inflation to merit. So we got to offset that before we start growing it again. So even in our projections, there is as there is in every business, there is inflation in merit you got to offset before you start showing the improvement.
So when we did our own modeling of markets and we did some scenario analysis, our goal is to drive earnings and margin expansion year over year. There are headwinds that we need to deal with. We got to have a portfolio of projects that can offset that. One of the comments that was made questions that was made earlier is, if the market is weaker, what do you think? Well, I think the good news by even with our operating models, we actually have a portfolio of projects we can choose from.
And what really constrains it is capital and resources. And if we see in our situation that we need more of the OpEx than the top line, Scott is going to shift the lever and say, listen, we got to start accelerating our operational projects versus the commercial and that's what we'll do. So one of the takeaways we want to leave you on 2.0 is that it starts with the very earlier chart Scott showed, that big drop in revenue. Some of it was obviously due to FX, but the huge drop in profit. We want to be more resilient, and I think we have a playbook that can respond.
We'll have better insight to what's coming. We talked about CRM. And the operational muscle that Scott and his team is building is going to help to deal with the uncertainties in our market. We know our business is cyclical, we'll be able to deal with it in a more effective way going forward.
Follow-up there on working capital. I think the DSO target works out to be about 65 days from the 81 that it is now. Flowserve actually laid out, I think, 60 to 65 day DSO target about 7 years ago. Can you talk about I think I was in high school about that. Then.
I think can you just talk a little bit more about how you get to that target? What the company didn't do correctly?
So I thought in my prepared I'll answer it Scott. Okay, go ahead. I thought in my prepared remarks, I highlighted the headwinds. Systems, focus, processes are not where they need to be. So right now, we're, I would say, doing very much a manual process.
We looked at our order to cash process. We see there's a lot of variability between how we get orders. For example, sometimes in the process today, we win an order, we don't actually know who to invoice. There wasn't a process step to like who do you bill. We see location by location.
Sometimes we invoice daily. Sometimes we invoice at the end of the month. Our applications of cash are inconsistent. So unfortunately, Scott talked about silver bullets, it is a lot of stuff. And what we're trying to create, actually with Jay's leadership here, is a standard process of how our OTR is supposed to or OTC process is supposed to work and get all the variability out and get to a common way of doing it.
Then over time, what's really going to also help is the ERP strategy that Scott talked about earlier. Having 1 or few ERPs will provide more insight and more data to be more active around our collection. So I think one of the good things I'm really excited about and the gentlemen here around the table are, I'm not sure there was a focus on working capital as there is today. These guys every meeting it's like, okay, where are you on your collections and where are you in driving it and these guys are doing a lot and having that ownership goes a long way.
Sounds like you probably need some investment here to get the systems up to speed. Any guidance you can give us on where we should expect CapEx to be over
the next few years? So let me just talk about 2019. We'll give guidance on 2019. And I think Scott alluded to it in his remarks. We are evaluating what our ERP strategies.
We know these things are expensive. We're trying to do the best that meets our needs and obviously is fiscally responsible.
Fair to say, we've cut back dramatically on capital in the last 2 years, and this year would be no exception. And I just I don't think we're there's no scenario where we double or triple our CapEx. So we're going to be very mindful of that spend. It will have to go up though as we invest more into these IT systems, but it's not going to be anything dramatic.
One last thing I would add to Scott's remark on that. Again, it goes back to the enterprise framework. I would say historically there was a lot of entitlement spending. And right now, we're really evaluating our CapEx on an enterprise view and leveraging it on an enterprise. So it's not necessarily one location.
It's like what's going to help the total enterprise. So we've really shifted where we're spending it. And I think we're actually getting more return for what we are spending.
No question. We have time for one more. Is there any other question? Okay. Yes.
Thanks, Scott. So if I go back through your slides and add up and look at your factories and add up how many factories you have in Europe, you still it looks like you still have about 40% of your manufacturing base in Europe and about percent of sales. So do you think that's the right mix? Like what does that change? How does that change over the next 5 years?
And what can you do to
push more of your manufacturing to low cost regions? So it's a really good question. It's a good question.
What I'd say is, Fulstrop has gone through a very aggressive and timeline in closing a lot of facilities, and we need to press the pause on that and let a little bit of the dust settle and kind of reconstitute from a manufacturing standpoint. And so 'nineteen, the focus is all is going to be primarily around productivity and driving the internal productivity at each of the facilities. And then as we go into kind of a more normal cadence on manufacturing operations, then we start to selectively take more roofline out of the system. So my personal view is that we have within the roofline that we have today, we could grow substantially from where we are without having to add a new facility. But we need to rewire and continue that re circuit.
But what I'd say is not going to happen in 'nineteen, we'll pick that back up in '2021. Still opportunities there, though. Yes. All right. So we'll close out the session, but we very much appreciate your time and your support today and appreciate your interest in Flowserve.
Thank you.