Flowserve Corp. - Analyst/Investor Day

| About: Flowserve Corporation (FLS)
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Flowserve Corporation (NYSE:FLS) February 1, 2012 9:00 AM ET


Mike Mullin - Director of Investor Relations

Mark A. Blinn - Chief Executive Officer, President and Director

Thomas L. Pajonas - Chief Operating Officer and Senior Vice President

Michael S. Taff - Chief Financial Officer and Senior Vice President

Unknown Executive -

Thomas E. Ferguson - Special Advisor To Chief Executive Officer


Unknown Analyst

Robert Barry - UBS Investment Bank, Research Division

James Foung - Gabelli & Company, Inc.

William D. Bremer - Maxim Group LLC, Research Division

Jamie Sullivan - RBC Capital Markets, LLC, Research Division

Mike Mullin

Good morning, everybody. It looks like we're about -- we're ready to get started. Welcome to Flowserve's 2012 Analyst Day, what we recognize as a very busy day for many of you during earnings season. So thank you for being here.

Joining us today are Mark Blinn, our CEO and President; Tom Pajonas, our Chief Operating Officer; Mike Taff, our Chief Financial Officer; Dick Guiltinan, our Chief Accounting Officer; and Ron Shuff, our General Counsel.

A few items before we get started. Today's event is being webcast, and it will remain on our website for several months for review. With respect to any forward-looking statements, we refer you to our presentation materials today and the Safe Harbor statement. All the referenced items are available at our website, and we ask that you review those carefully.

As many of you know, we plan to release 2011 earnings on February 22. Today's discussion is going to be much more longer term, forward-looking and strategic focused. We'll address 2011 results in greater detail when we close our books in a few weeks.

Today's agenda will kick off with Mark Blinn with an overview. Tom Pajonas will give an operations view, and then we'll take a break for a few minutes. Mike Taff will follow with a financial update. Mark will conclude with some comments, and then we'll kick off the Q&A. So once again, thank you all for attending, and I'll turn it over to Mark.

Mark A. Blinn

Thank you, Mike. Is this working? Good morning. Thank you for making it. It's a little different from last year for those 11 of you or 12 that were here last year in the snowstorm. So we got different weather today, and we’re glad to have it. But one housekeeping matter, just as -- before we start. As part of regular process, every once in a while we seek feedback and input. And the sense we got is that this meeting is a little early from the standpoint of you've got a lot going on, conflicting schedules. But also, you'd like to see it closer to our year-end earnings so we can talk a little more about current trends. So we heard you, we thought about it, but a lot of you had already scheduled to come in. So what we'll do is we'll take care of that going forward. And the purpose of this is really, as Mike talked about, is to help you understand our business so that when we talk on the earnings calls, we're relating back to these discussions.

So what I'm going to do is -- there's a lot of material to cover. Tom and Mike are going to go into a lot of detail. I'll try to keep it to kind of summary level and really cover a couple of areas. I think one thing I want to do is just review some of the actions we'd taken over the last couple of years, particularly more recent actions, and just hope you understand what we were thinking and then describe the business and really in the context of our strategic intent. You've seen them before, so I'm not going to go through them in detail, but really just talk about some of the things about our business aspects to help you better understand our business.

Resource allocation. As a senior team, we think that's one of the most important things that we do. And it's not only capital, it's people, how we allocate resources and what's important, and then look forward and talk about growth. Because all the themes that we're talking about here are focused on disciplined profitable growth and driving value for our shareholders. So really, those are the 4 themes that I want to cover today.

So what have we been doing? We've been repositioning through the cycle. We are in a cyclical business. You look at our earnings, it may not seem that way because they weren't as volatile as you saw with other industrial companies. But the fact is that we have been through a cycle. This is a cycle that started in our order book at the end of 2008, but you really didn't see it in our P&L until the end of 2009, mainly because of some of the long-cycle nature of our business in the late-cycle.

So what have we done as we position this? Well, we managed costs, focused on margins, we pretty much put finishing touches on our realignment programs, focused on operational excellence and tried to stay very disciplined during this process. And what I mean by that is we looked at early 2010, the discipline was around the margin in some of these projects but keeping our facilities absorbed. That's the discipline we used during this period, and we are starting to emerge from it.

Now as you know very well, Europe is still a variable. And my sense is that they are certainly making some progress, but it's going to require them firewalling some of their risk and taking action around some of the treaties and agreements among countries. Also, we shifted a lot of manufacturing capacity. Some of our LPO/SPO strategies which we'll talk about -- Tom will talk about in more detail. We drove a lot of our aftermarket initiatives into the emerging parts of the world where the growth was. We had a good base of aftermarket capabilities, particularly in the Gulf Coast region. We started blowing those out to emerging parts of the world. And we added and actually repositioned a lot of people into the emerging markets. That's where the growth is. But we also made some local investments. We built out facilities in the Middle East, built capabilities in India, in China as well. And also, we grew our QRC network. And that really resulted in a record quarter in the third quarter of last year in aftermarket bookings.

As we look at our markets now, we continue to see growth in the emerging parts of the world. They’re building-out capabilities in the Middle East, a lot of greenfield projects. We see they're going to start to invest in Brazil, India, China as well. So the emerging markets are still spending on infrastructure. And we actually have seen some improvement in North America. We were real encouraged by what we see towards the end of the year.

If you look at our long cycle business, we've talked about a year ago, we were described [ph] being competitive. What we've seen is some stabilization in the pricing. It's still very competitive. But we see that, that's going to start benefiting us in periods to come as this goes into backlog and rolls out to our P&L. We are still working through some of the backlog that we've put in there in 2010, late/early 2010 and some in 2009. As we've talked about on the third quarter call, this backlog, we expect it to roll out through the next couple of quarters.

Also, our short cycle business. We saw the volumes pick up in some of the areas. And in some areas, some of the pricing has followed. So where we sit right now is we've got a large backlog, realigned platform. We've increased our aftermarket business. You look at the trailing 12 months run rate, it's a little over $1.8 billion. We've got a global presence, broad product portfolio, and we think that's positioned us very well for 2012 and beyond.

Let me focus on a couple of other things that we've done over the last year. Really advancing what I'd call the One Flowserve initiative. If you think about what we did 2 years ago in integrating pumps and seals, it's a real benefit for our customers. The customer-facing side one-salesperson drove the aftermarket capabilities. And as we looked at that over the course of the last year, I realized we have a real opportunity to really integrate the valve business to drive that one face to the customer and drive the aftermarket capabilities.

But at the end of the day, we took a -- I took a step back and focused and said, what we need to do behind that is really drive improvement in our operations. And so what I decided to do at the end of the year was create a COO position. And then as I looked down at Tom here, I had one of the best candidates in the industry to take that role. And so that's why we promoted him to COO of the company.

We also saw improving financial performance, solid bookings, revenue and earnings growth. And we also, as I said, put a lot of the finishing touches on our realignment activities. Also, organizationally, we added an Independent Director, Dave Roberts, with upstream Marathon. He can bring us a lot of insight into an area where we're going to see continued investment; and a new CEO, Mike Taff. You'll get to hear from him in a moment. Some of you got to talk to him. Very deep experience in industry on the project side, very relevant to our business. And also, as we saw increased confidence in our business as we were working through the cycle, we increased our return to shareholders of cash through share repurchases and of course, dividends. And we acquired Lawrence Pumps. I'll talk about that in little bit.

So is describing in your business, and I know you've seen this before, it's important when we look to the future that we consider the past. And the point I make about this is, we have heritage, brand names and capabilities all around the world, and our customers know and have a tremendous amount of experience with it. If we were a technology company, these years would be months. And what I mean by that is the technology in those industries changes so quickly, customers come and go so quickly that you really have to be way ahead on the innovation. In our business, the centrifugal pump has been around for 160 years. Now it has changed a lot in terms of its application. But the point is, in our business, there aren't killer apps that come in, and displace you. And customers know that. We also look at our balanced portfolio. We operate in 3 segments, and we operate across a number of sectors which are really core sectors around the world. The Engineered Product Division, these are highly complex engineered pieces of equipment. And actually, it's beyond equipment. I was talking to somebody earlier -- 10 to 15 years ago, a lot of what we did was manufacture the engineered air pump. And the engineering contracting firm, another supplier, would take it, integrate it into a package. Now we do a lot of that integration. And that's why there's a real benefit having a seal business, sealing systems and some of the other things that we have around this package. Because now we have more content that we're delivering to the customer.

And of course, related to this is higher attachment of aftermarket services. Our Industrial Products Division, oftentimes folks think this is made for stock equipment that sits on a shelf and hopefully somebody is going to buy it. That's not the case. It's configured-to-order. And what it means is, there's a lot around metallurgy, particularly in the chemical business. There's a lot of specifications around this type of equipment. And it is engineered as well. And the importance to this is this works with EPD as well, because a lot of this is balanced to plan and also has that aftermarket attachment as well.

And then our Valve Division. Valves and automation. You do have some quarter-turn valves, but you also have some very highly engineered control valves with automation that sits around it.

Innovation, technology. Remember that slide I showed you earlier about 200 years of experience. A lot of the innovation comes -- it's really customer-led. The customer says, "I need a geothermal application. I need an application that will help me make the process more efficient in the tar sands. I need an application that will work 2 miles down on the ocean floor." So we work with our customers to drive this kind of specifications and engineering capabilities into the product. And we continue to work on that because what we're always looking to do is move up the complexity curve. Why? It's what our customers want. It's what we're good at. We have the capabilities for it, and there's good aftermarket attachment.

Another thing as you look at our business around strategic localization, we've really been tilting towards the emerging markets. You can see over the last couple of years, our bookings have grown in the emerging markets, and our employee headcount has grown in the emerging markets. What you'll see a little later is -- part of this realignment was we took people out of the more mature markets and created that capability over in the emerging parts of the world. This is where we see growth, good growth in our business. This is where there's going to be demand. Not that there's not going to be demand in the mature markets, but this is where the growth is going to be. This is where our customers are going to be. This is where our customers want us, and that's why we're getting there.

So I talked a little bit about One Flowserve. You look back 15, 20 years ago and what you saw was that the refinery, the processing plant, production capability, that's really what drove all the decisions. And that's still the case in certain instances. But what we're seeing increasingly is our global customers want to face one supplier. Our Shell frame [ph] agreement is a great example of that. We've basically got sole source for our control valves all over the world. That's what customers increasingly want from their suppliers. And so this also supports move towards the COO role as well. But what you see now is we can bring broad product offering, leverage the aftermarket for our common customers across common markets and really respond to some of these global megatrends that Tom's going to talk about later.

I mentioned the COO structure. If you look a couple of years ago, we operated across 3 organizations, strong markets that supported that. But the fact is oftentimes, there were different processes. There were sometimes competing interests as well. And then we moved to 2 organizations with the integration of pumps and seals. Now we see the opportunity to drive to one unified organization. What that will benefit is on the project pursuit, the common processes. This will really get us some of our expense leverage that we think is an opportunity out there as we talk about SG&A and other expense opportunities and these global agreements with our global customers as well. More important, this is really about culture. This is really around driving a culture around a common focus. So we see real opportunity with this move.

So when we talk about resource allocation, this is really how we look at our business. Folks oftentimes have said, Razor/Razorblade, why don't you ramp down your original equipment? More aftermarket? But this is really how we allocate our resources. We want to get a return on our opportunity costs, our people, our money, our dollars, our euro, whatever it may be. And so when we look at investment, we have to look at capital project activity. Because if you're not on the capital projects, it's not like you're going to be able to get the aftermarket. Your customers want you there. But here's what we're focused on: we're focused on responding to more complex applications and designs. One of the investment is we increased the capability of some of our test rigs over the last couple of years. What customers want with these highly engineered pieces of equipment is they want to see them work before they're deployed out in the field, and some of these pieces of equipment are getting very, very large. So we've increased the capacity and the capability of our test rigs, some of our machining, computerized machining, some of our design efforts. Also, we're continuing to focus on the downstream, but we've been moving more midstream and upstream with some of our technology designs, some of our investments, some of our focus. Drive project execution excellence and leverage our LPO/SPO strategy. This is a strategy where, in a sense, we're starting to migrate some of the manufacturing to the low cost, emerging parts of the world. That not only supports customers around the world, but helps develop those capabilities in those emerging parts of the world. What that will do is create an installed base that will create an experience with the customer that gives us the opportunity to drive our aftermarket services and solutions.

So it's not just a matter of creating that installed base and waiting for the aftermarket. We've been investing in our aftermarket capabilities, diagnostics, the Integrated Solutions Group. And this is around not only capturing our equipment, but other folks' equipment as well to drive efficiency and capabilities overall.

At the end of the day, what we want to do is bring stable earnings and cash flow and growth to our business, therefore, drive shareholder return. And in fact, when you look at this end-user strategy that I've just laid out for you and look at our earnings, our sales and our gross profit over the last couple of years, that's in fact what we've done -- is we've had stable earnings. When you look at other industrial companies and you see their earnings, they declined significantly and then increased. We held relatively stable earnings over the last couple of years through what was a significant cycle in our business.

High focus on total shareholder return. And what we do, you look at the past as to what we've accomplished, what we do is we balance organic and inorganic growth, focus on operational excellence, look for geographic diversification and then also focus on returning capital to our shareholders as well. So that's what it all comes down to. Our resource allocation is driven towards driving our business and providing returns to our shareholders.

So let's look forward a little bit. Probably you all have seen this data. You can see that the GDP outlook for global -- globally 2012 looks weak. A lot of this is driven by what's going on in Europe. And I was talking to some folks earlier, this is certainly impacted over the short term, the outlook overall for our industry and other industries as well. The sense I get is that they are going to go through a recession. The question is how deep is it going to be? They did apparently avoid really a liquidity crisis in November of last year and seemed to have gotten past that. But now it's around firewalling a lot of the risk and also getting some sort of an accord amongst the countries there in moving forward. The sense is if they can do that quickly, they'll be able to avoid a deep recession.

Also, if you look in 2012, we've got elections, particularly in the United States. That can certainly impact the global outlook. And also, you've seen major global banks have been easing out there, which can benefit some investment.

As you step back though and look into the advanced economies, what they see short-term, medium-term, 1% to 1.5% growth, with stronger growth, certainly stronger growth of 3%, 3%-plus in the emerging and developing countries. But if you look at our data, our data shows 5.9% CAGR growth over the next 5 years. So why is that above GDP? Well, there is a component of GDP that drives our business, but there's a lot more. One is energy demand. If you look at the anticipated growth in energy demand, it's 30% over the next 20-plus years. So that's on the demand side. And on the supply side, the supply is going to get more complex to extract. More complex to source. And also, there is a positive outlook in some of the renewables and nuclear power. The fact is, nuclear power globally represents about 20% of the power supply, and it is not going to go away overnight.

Also, there's regional drivers as well. If you look at the emerging markets pretty straightforward, GDP growth, population growth, demand requires new infrastructure build. But that doesn't mean that there isn't going to be investment in mature markets of the world. What you have there is aging infrastructure that requires upgrades, conversions, maintenance, repair, efficiency. I mean, if you think about regulation, regulation of carbon emissions, that's all about efficiency. It really benefits us from the standpoint that they're looking for an upgrade. They're looking for higher output, higher yields.

So what investments are we making right now? Well, we talked about this. We're investing in China and India and Brazil. That's where the markets are. That's where the demand is in our business. Also, our QRC network. And keep in mind, our competitors are doing this as well. QRC expansions in growing markets. I talked about this before. If you look in -- if you ever go to the Gulf Coast region and see our QRC network, we have very good penetration. We had a tremendous amount of success in that region of the world. That's what we need to do in other parts of the world as well.

And then our LPO/SPO strategy. This is around driving efficiency in our manufacturing. This is around migrating a lot of the activities where the growth is and where the capabilities are.

Another area of growth is acquisition. If you look over our history, 10 years ago, it was around consolidating the industry, major transformational acquisitions. More recently, what you've seen is more of the bolt-ons, and I'll talk about a few of them. But as we look at them, it's really focused on the bolt-ons. It's things that we can leverage in our business.

So as we look at acquisitions, our strategy is around paying reasonable multiples and also looking for internal rates of return. We like to see 15% or greater when we make an investment, unless it's safety-related. We also -- and what we'll try to do is get these things accretive within 12 months. A lot of the purchase accounting rules make it somewhat challenging to do that, because you have to write up customer lists and everything and amortize them over a relatively short period of time. We start with the internal rate of return and try to drive these things to get accretive.

But what are the benefits really that we look for? We look for strong brand recognition and good reputation in engineered technology. So we don't want to go out and buy commodities. An underserved market opportunity. Product pull-through, other products as well. Emerging market penetration. And what we want to be able to do is leverage our global sales force. So let's look at a couple of examples.

Let's start with the most recent one, Lawrence Pumps. Very limited sales force, strong presence in the United States, somewhat of a presence in China, limited in the Middle East, nothing in Brazil. So we could immediately load this product onto our global sales platform. And they were servicing the equipment through third parties. So we had an immediate benefit in terms of the aftermarket capability. Highly engineered piece of equipment, severe [ph] service.

Valbart. What that did is immediately gave the valve business a leg up in the oil gas and industry. They've been strong 4 or 5 years ago. In the chemical industry, we're looking to grow. And so what Valbart did is gave them a critical product and also allowed them to pull through a lot of their control valves as well.

You look at CALDER, that was around technology. The reverse osmosis desalination process has been around for a long time, but oftentimes hadn't been viewed as viable because it was such an energy consumer. You'd have to put these next to major power plants. Well technology, now has allowed that you can recover some of the energy off the process and go back and drive the pump. Now it's becoming more commercially viable. So we saw that as an opportunity because we had the pumps going into process to really drive further value and get wire-to-wire capability on the desalination process.

And all of this unknown [ph] resource allocation in the way we look at things is returning cash to our shareholders. We talked about this at the end of the last year. Our focus was around returning 40% to 50% in the forms of share repurchases and dividends. If you've looked over the last 4 or 5 years, we've increased our dividend at a good rate. So this is our focus to really balance our allocation, our resource allocation across the company, our customers and our shareholders as well.

So what does all this mean? Well, we are focused on growth. When we were here last year, we talked about wanting to grow our business 9% to 11%. What has changed is if you look at the EIF data, it's come down around 80 to 90 basis points. That's the difference. We are still focused on growing our business. And in fact, if you look at the last year, we were able to grow at about 12%. So our primary focus is going to be around organic growth. We are going to look at opportunities around inorganic growth, assets that we can see out there to drive growth in our business, further penetration. And that's going to be our focus. We want to grow the business, grow the business to return value to our shareholders.

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

Thomas L. Pajonas

Thank you, Mark. Just by way of introduction, I've spent the last 7 years as President of the Flow Control Division within Flowserve, basically driving the product and service business. And then 25 years prior to that, I was with ABB and Alstom, which is basically a project-driven business, in various roles, manufacturing roles and supply chain roles, engineering, project engineering roles and for the last several years of my career, ran the worldwide power boiler business, primarily on the fossil side for Alstom.

So with that said, let me go to the agenda overview. And basically, what I want to craft here is a story. And the story is made up of a lot of questions from many of you in the past as we've had this discussion over the last couple of years. And I've tried to put some details behind some of the questions that you've asked. So I'll start off with an overview of the business, and we'll talk about the industries served, products and the value chain. We'll take a short film, which is one of the major areas and pushes for us, which will be on the aftermarket side in the services and solutions business. We'll talk about the market overview and again, the products, the industries served. I'll go with a little bit more detail than the slide that you saw from Mark. It will split up the market. I'll talk a little bit about the prognosis in the different areas. Obviously, we want to talk about the key themes for 2011. And as Mark mentioned, we have some changes that we want to make structurally, so I'll give you some of the organizational structural changes we're going to make on the platforms. And then lastly, the key initiatives, which I'll have as a basis as we begin to drive the business over the next several years, and then lastly, the growth plan.

So let me just talk about the industries that we serve. And again, the point here is that each of these industries are unique. They have various characteristics in terms of how to serve those industries. And what I'm going to try to demonstrate to you over the next 45 minutes or so is how we serve these industries and what makes us unique versus some of our competitors in these particular businesses.

So the characteristics. These customers tend to have a long-term view. So while they will react to short-term swings in oil price and gas prices and so on and so forth, there's a long-term view of our customers in the infrastructure businesses. If you take a look at the overall market, $120 billion market for pumps, valves and seals, and this is the total available market, I will define later on for you the market that we serve further on in the presentation. The unique thing about this business that we're in is once we get done selling the new products, we have now to service these products over a 40- to 50-year life. And in some cases, on the nuclear side, you're relicensing the existing units for another 20 years. So the span on these could be 70 years in some cases, which gives a lot of opportunities for us as we take a look at the overall aftermarket in the business. So if you take a look at our core business as products on the new equipment side and servicing this 40- to 50-year life, the business is what Flowserve is all about.

And then locally, we're also seeing -- not only are our customers looking at the total life cycle, we're also seeing a shift in terms of the value chain also becoming more localized around the customer bases and where the markets are headed.

So just a little bit about the attributes of the products and services. Certainly, first and foremost, when we put these products into service, these products have to work. If you have a main steam isolation valve in a nuclear power plant that has to close in less than 2 seconds, that valve has to work, and it has to work each and every time that, that plant is called on. And they're not stroked that often. But when they do get called into operation, it has to work. So the amount of engineering and critical technical content, quality control around our products, in many cases, is quite high.

The next thing that becomes very important, particularly on the engineering, procurement and construction cycle as well as the end user, is the on-time delivery. The schedules are very complicated, most often 3 to 4 years as a minimum on many of these large infrastructure projects. The schedule becomes very important in terms of meeting the overall requirements from both our EPC, as well as the end user. So that becomes a driving force in how we structure and how we define our supply base, our engineering base and our manufacturing base worldwide in an effort to meet these on-time deliveries.

We're also seeing, as I mentioned to you, several of your earlier this morning, lead time becomes very critical, too. So on-time delivery goes together with lead time, and we're also seeing shifts in the market from time to time in terms of lead time. Depending on the capacity in the business, the lead time will ebb and flow depending on that capacity. And then, obviously, you see here, in terms of the attribute, our products have to be in service for the 40 or 50 years, and that's a key component.

If we take a look at our customers, I've broken them down to 4 different types of customers, and each one of these are radically different than the next, all driving for the same type of an objective, which is to get the plant in service at the scheduled time for the correct price, and also to then be able to operate this plant efficiently over the 40 to 50 years.

Here, you see 4 of our customers: the end users; the EPCs; obviously, the original equipment manufacturers; and then while distributors are a route to market for us, they are also a customer to us because we do sell to these distributors. But it is a defined route to market as opposed to direct through our own sales force.

You see here a number of different characteristics. I'll just pick one, a simple one in terms of specifications. Depending on who we're dealing with, the level of detail on these specifications can be astronomically different. So if we're dealing with EPCs and original equipment manufacturers, very detailed specs, several inches high of requirements in terms of performance, in terms of warranties, in terms of code that you have to meet, a schedule, details behind that. The end users tend to have a little bit more simplified specification and obviously being more concerned about the overall operation of the plant over the next 40 or 50 years. In many cases, the distributors are basically taking the specs from either the end user or the EPC or original equipment manufacturers and flowing that down to us. So we have a wide berth of different types of customers that we’re dealing with here, and many of the customers that you see below this are customers that you'll recognize from being in the industry.

So how do we go to market? We have almost 1,200 salespeople worldwide that go directly to our various customers that you see on the other page. There's another 500 third-party reps that work directly under these direct sales people. So that's a quite large grouping out of 16,000 employees. You can see how much effort we're putting in on the upfront sales piece.

We deal with about 520 distributors worldwide, and you see the mix there between the FCD organization, as well as the FPD. And I would say, most importantly, we have technical service reps that are in the plants on a day-to-day basis, providing equipment, services, consultation, recommendation to our end users that also act as a front-line sales force in this particular process. Very important piece for us, the customer touch point. And you will hear that throughout the entire presentation. That is one of the characteristics that we drive in our business.

Now our route to market. Here, what I just want to depict, and these are, I would say, directionally oriented, and don't take these as specifically because it varies from year to year, but there are some fundamental differences between the FSG organization, which is pumps in the seal and aftermarket service business for pumps; and the FCD business that you see there. The FSG business tends to go more direct to the end users. So projects are bigger in that particular business. So you're dealing in many cases with the end user. Their aftermarket concentration is different in terms of how they sell versus the valve business. So you would tend to see a higher end-user percentage, which is what that's showing. The EPC business also is larger than what you see on the FCD side, again for those same reasons. The FCD business has a higher concentration through distribution. So we typically run our business on 35% to 40%, 42%, 43% distribution over the years, and that is a way that we go to market. It's a defined way. We've elected to go to the market that way, and it's been very worthwhile.

Many of you over the last couple of years have asked about schedule. So what is the schedule for a particular type of project that you do? How long is that schedule? What is the visibility into where the customers are headed relative to the different markets? What I've tried to depict here on the topline that you see there, is we have schedules that range from weeks to 7 years from start of development to commissioning of that particular part and/or project. So that could range from weeks to an aftermarket job, or years if you're talking about a large refinery or a nuclear plant. The aftermarket, as I've mentioned, is another 40 to 50 years, plus relicensing in certain cases on the power side. So you can see the breadth of the span that we have overall in the business. I've also tried to point out here in the development cycle, when we start early on, on these projects, in some cases, 7 years before the project would actually be put into commercial operation, we are working upfront with the EPCs and the end users in helping them define technical specifications and providing them -- maybe preliminary bill of materials, helping them with the overall design, providing them power inputs into pumps. And on the valving side, providing them sizing, providing them upfront weights. We try to also -- in several customers, we've actually taken our technical engineers and put them in their offices during various pieces of the development cycle in an effort to help out the cycle. So we do have, in many cases, a long insight into the project business as we deal in this upfront area.

Also, over this development cycle, we're working with several of the EPCs that may be working on the same job. So we're –- while we're keeping the data separate. We also are working with several EPCs that may be going after the same job until one of the EPCs is chosen. So again, we have some good visibility into the overall work.

So once it leaves the development cycle and goes on to the RFQ stage -- oh, flip back, Mike. So once it leaves the development stage and goes on to the request for quotation cycle there, that process could be, from RFQ to purchase order, could be another 6 months. And then from purchase order to shipment, you see down below the various spans that I've provided you from a large order like a refinery, a nuclear power plant. We could have pumps that are 24 months in terms of PO to shipment. Valves, you see the number there. And certainly, seals is much lower. So as we cycle down through the large to the small projects, it will give you a feel for the different level of schedule attributes that we have across the wide-ranging projects that we have overall in the business, all the way down to the aftermarket, which could be a 24-hour service between the time we get the purchase order and actually get it on site. It could be 24 hours. And you'll see later on, with our 170-plus Quick Response centers located around the world, that is one of the goals that we have is to drive that aftermarket in terms of very quick response.

So another way of looking at the overall schedule, and I've blocked this into 3 distinct areas. In the first area, it's, I call it, the proposal of business and development cycle. What we are trying to do is we're trying to provide to the customer a certain level of technical expertise to help them define what they may need in their particular plant. So bill of materials, pricing, cut sheets, drawings, arrangement drawings. So a lot of upfront work in this area in support of the overall project.

In the middle phase, once we get the project, that's where our competence comes in, in terms of our manufacturing core competence, our design core competence, our ability to source around the world. Many of these large projects have localized sourcing requirements based on the financial structure of the project. Because of our ability to source around the world, we have the ability to work that effort there in terms of meeting the overall financial requirements, sourcing requirements for our customers.

And lastly, the third stage that you see there is basically the aftermarket stage. This is the 40-year life cycle that we're after. We provide localized support over this particular time period. We're trying to set up a lot of alliances that get at this spend here for the customer, all in an effort to make them more efficient over the 40- to 50-year life.

So many of you have asked, what differentiates Flowserve from the competitors, and how do you maintain and sustain this differentiation over time? Well, what I depicted here is several different areas of differentiation: product features, project management, localized services, the supply chain. All of these, I would say, ebb and flow differently over a cycle. So if I can just pick one attribute here, we may have, under product feature, a competitive advantage in terms of size and weight in a particular pump or a valve. Over time, that differentiation may become less and less as the competitors launch their research and technology efforts and develop the product and so on and so forth. So over time, while that one may become more common between the competitors, we may have other items that become more of a significant driver like localization. So I may have the same type of size and weight, so I'm not getting any credit for that, but then if I have a localized Quick Response Center near the client that's able to service that client once they put that product in service, I create a competitive advantage there. I may have a competitive advantage in terms of sourcing, that I'm able to source these particular products locally in order to help out the financing package for the EPC customer in that regard.

So these attributes change over time. We've maintained different types of sustainability relative to our customers, and what we're trying to do on each and every bid is put these together in a matrix that gives us that competitive bid on that specific project worldwide. You'll see later on, when I present to you some of the structural changes that we're making, how we want to do this more in the way that Mark Blinn has depicted as One Flowserve going forward into the future.

So a lot of discussions in the past in terms of the competitive landscape. I've tried to show here who our major players are. And in all of the areas, maybe with the exception of seals, we have a whole host of regional players too long to list here. But these show the big players in pumps, which you see there to the left. You see the big names, Ebara and Sulzer, United Technologies. You see on the valve side, Tyco, Cameron, Emerson. And certainly, seals, Smiths, Burgmann and AES, all very reputable, very good, solid competitors.

In the middle, you begin to see some distinguishing players that now have a couple of the components that we sell. So we sell pumps, valves and seals and services for those. You now see some of the competitors are beginning to have some of those components, but not all of the components. Flowserve has both the pumps and valves and seals, which we fundamentally believe give us a unique perspective relative to our overall clients.

In terms of the overall market and where people play, again, this is directional. I've tried to just highlight where everybody plays. You can see a more uniform play across the power business, a little bit less uniform play across all the different competitors on the oil and gas and chemical. And GI is probably the most distinct, because GI here includes pulp and paper mining. It includes pharmaceuticals, district heating and so on and so forth. So it's many more varied industries on the GI side, including distribution in that particular market.

I've tried to give you some data here. And again, some of this is approximate data going back to 2010. So for the pumps, seal and valve business, the way you would read this, is this is where the competitor plays in that particular market, pump, seal and valves. The percentage you see there is the percentage of pump, seal and valves of the total revenue. So on the first example, 21% of the total revenue is pumps, valves and seals, and that equates to $1.2 billion in that example. So again, you can see the varied nature of the competitors. Flowserve, by and large, is one of the top players in this area at about $4 billion but uniquely, I think, situated where -- this is our market. This is where we play in the flow control area, and that is where all of our products and services are centered on.

So I'd like to just briefly play here a video. It's only about 3 or 4 minutes long. For those of you on the webcast, you can find this on the flowserve.com/videos and go to Services & Solutions. And it's about our aftermarket business. So this is the 40- to 50-year life product and services that we have.


Okay. So just before I get into the total available market -- I mean, you can certainly see here that over this 40- to 50-year life cycle, the opportunities that exist in terms of servicing those particular products, and it's variable. So on a nuclear power plant, you're going to have more defined service schedules that get set up on a standard basis over the 40-year life. You're going to have opportunities to go in and upgrade equipment. You're going to have opportunities where the customer wants to perhaps get more power out of the same plant. So the service capability can range from supplying parts to supplying major revamps and retrofits over the 40-year life, which can be quite significant in terms of the overall project cost on that basis. And that's a very exciting area for us, and you'll hear more about that in the future slides here.

So let's take a look at the market now as we take a look at the total available market. I've mentioned previously about a $120 billion market overall. What I've done here is to try to depict for you the amount of competitors in the market. So the blue represents the most significant competitors that you saw in the previous page there. And you see here that they represent, for both the valve business as well as in the pumps area, about 12% of the total available market. The rest of the red is serviced by regional and local players in this particular business. The red also represents opportunity for us overall in the business. When we make a declaration in terms of what market we want to go after, what products do we want to have, what research and technology we want to drive, we're looking at how to expand and make us more efficient in the blue. We're also looking at how to expand more into the total available market in the red. We also, as I indicated, declare there’s certain businesses that, for whatever reason, we don't want to be in. We also make that declaration, and that's part of the overall red.

In the seal business, you see there much different picture. A few of the players that you saw on the other slide make up about 70% of the business. So the dynamics in that market are substantially different than in the other businesses that you see there.

I've taken the same market to try to give you a little bit more color behind this. Of this $120 billion market, I've now broken it down into the served market for pumps, valves and seals. You see there over the last 3 or 4 years, that served market has averaged around $85 billion to $90 billion. That is the market that we play in, too, at various levels. And I've also shown here the growth of the emerging versus the developed market as that emerging market is taking on a greater and greater emphasis as you've seen here over the last 4 or 5 years. And I do think 2011 was the first year that had crossed over more in the emerging market than in the developed regions. So again, a sizable market.

One further, I would say, characteristic -- attribute of this market, I've -- over the years, a number of you have asked, well, where do you play in upstream, midstream, downstream? What about the power market, how much is nuclear? How much is fossil? What I've tried do here in this simple depiction here is to give you 3 or 4 different pieces of data. So shown to the left is the total available market. You see there, for oil and gas, it represented at $30 billion; chemicals, about $20 billion; and then power, you see there at around $10 billion. You obviously have GI and then the other markets, which are more disparate, that make up the remaining to get to $120 billion. If you look at the FLS bookings at trailing 12 months in Q3, you'll see 40% of it was oil and gas, roughly 20% was chemicals and so on for the power business. Shown here in this chart with the hatchings in the circle are the level that we play. If you look at this and took it in aggregate, it probably represents about 65% maybe of that overall market. 70% of that overall market is where we play, which is where we get approximately the $90 billion out of the $120 billion.

You see here on the oil and gas business, we are in upstream, a little bit more in midstream and more heavily into downstream, based on the history of companies and so on and so forth that Mark showed you in his overall presentation. We have the ability to flex and to move within these different regions as we begin to grow more and more into the upstream area and the midstream area. Mark showed you a, in one of the acquisitions we made most recently on the valve side, that we moved more into the midstream with the acquisition of Valbart with the products that they had in the transmission and distribution side of the business.

And the chemical market, heavily into the petrochemical, I would say, oil-based type market. Specialty, we're pretty well represented. In pharmaceutical, it's a good, good business, it tends to be more fine metering on the valve side and on the pump side. It requires, again, a different level of expertise in that particular business.

The power is probably the most uniform across all the different businesses, including the alternatives. We've had a long history in nuclear, have spent a lot of money in maintaining our certifications, our quality certifications in particular; have been involved in fossil in the movement over the time to supercritical units; and certainly, combined cycle gas units, which we're probably going to see more and more of in the next several years.

Alternative energy, we're into biomass, we're into solar. We have some good projects, products in the solar business. So again, a wide market that we serve to various degrees.

Just a few words before I get into the specific markets. Hopefully, up to now, you've seen, I mean, the market is fragmented in terms of competitors. That is, the market we play in, it's a characteristic. It gives us a competitive advantage and it also requires us to look at those differentiators that I showed you earlier to see how we specifically differentiate for our business, and hopefully, you have an appreciation for the complexity around that differentiation.

The cost of failure is high in this market, so our products must work. We put a lot of effort into quality, and our products have to work and be on time, so that will be 2 drivers that I will certainly continue on in this new role.

The emerging market is growing. It doesn't mean at the expense of the developed market. The developed market still is very important to us because there are some unique things beginning to happen with the developing market. If you look at the U.S. alone with the shale gas, the developed region may change the landscape in chemical markets in the future, based on having very inexpensive shale gas available for the chemical market. So these markets change over time and what was a developed market could become a good market in the future.

In terms of the competitive environment, I would say a couple of things. There are competitors around the world that are starting [ph] to gain global acceptance. I would say many of the most recent events, albeit maybe unfortunate events, that we've seen on the nuclear side and maybe some of the other situations in the oil industry require now more scrutinized products in terms of quality, processes and systems. That's where a multinational like Flowserve has an advantage in having good, solid quality systems that can be ported to its manufacturing units around the world and be driven throughout our particular supply chain as well as our manufacturing base.

So what drives the long infrastructure cycle of business? I mean, it used to be just profits. And in, the profits will never go away in terms of our customers and end users, those will always be there. But other things have begun to come into play, in some cases, in a leadership position and, in other cases, in a balancing act with the fact that the projects still need to be competitive. So for instance, if you were to take a look at energy independence, you would look at areas like China, you would look at areas like the Middle East and declarations that they want to have certain types of systems in place in order to have that energy independence. Whether that be starting up petrochemical plants, whether that be a defined power strategy that they have in those particular markets, that energy disparity [ph] becomes a balancing point against just the economics of a particular project.

Also, one of the areas is the growth as more people move to various urban, in-city situations around countries. They require different levels of power and economic stability and so on and so forth. That begins to drive a lot of the infrastructure developments that we see here. So a much more complicated landscape than just profit alone, and what we try to do is we try to use these type of drivers as we begin to craft how we bid the proposals. We may have local content in some cases if we're trying to build up local content for local employment, so we may have local content rules that come into play, as one example.

So now let's get into a little bit more about the markets. Mark covered a couple of these, but just maybe one level below that. Shown to the right here is total demand. So you see there's total demand in billion tons of oil equivalent, so that's a way to put all the different types of energies on the same type of units. So you see the growth there going from 12 to about, to almost 15 over this basically 10-, 11-year horizon.

The interesting thing in this particular slide is you still see that the contribution source predominantly is still going to come from oil being 30%. Now it's decreased from 2009 by a few percentage points but still the predominant driver in terms of where that fuel source is going to come from, followed by coal, then followed by natural gas. And natural gas is rising pretty significantly, i.e. with what's going on here in North America and also some of the movements that we're seeing around the world in the Middle East and in Europe also in this particular area.

Also shown here, you see the renewables growing the quickest on a compounded annual growth rate of almost 10% over the same period. And again, while they're growing the quickest, you see the overall contribution is still fairly low versus the coal, the oil and the overall gas in the big scheme of things. You see nuclear there growing at about 3%, making up about 6% of the total contribution, also which will be a factor. So this represents, I would say, a balanced portfolio. It gives you a relative feel for where the sources are and it also gives you a relative feel for what we will be driving for in the future.

So let's take each area in succession here. And again, just quickly, the way to look at each one of these slides here: You have the total demand there. You have incremental demand shown to the top, and then you have something in terms of where the supply is coming from, to give you an idea. So here, the total demand is growing from 88 to 95 million barrels per day. You see, incrementally, it's coming from China, it's coming from Middle East and Africa in terms of the overall demand, including rest of Asia. And you see down below that the oil production is still largely on shore, except you see now offshore and harder-to-find crude is beginning to take a increasing play overall in the market. So higher pressures, higher temperatures, more critical applications, that is the type of business that Flowserve is very good at with our technical content, our technical applications, the slide I showed you before in terms of the overall schedule being upfront in the process with the end users, with the EBCs. We like that type of work because we can get in there and really distinguish ourselves and differentiate ourselves from some of the regional players in the overall market.

Natural gas, very interesting what's happening with natural gas. I'm sure most of you have seen gas, and it's now hovering, at least in the U.S., around $2.50 per million BTU. It's basically changing, beginning to change the landscape overall. You see here gas demand growing in the next 10 years from 3 trillion meters cube per day to almost 4 trillion meters cube per day, so quite a substantial overall demand in the business.

Incrementally, you see where the demand is coming from. Again, China has one of the biggest areas and regions. And we tried to also break down and provide a little more detail where that demand is coming from. So you see in this particular case, while China is the highest, you see power being one of the biggest areas, as well as general industries, use of natural gas in that particular area. So you can kind of cut through this slide and peel the onion back, so to speak, and get some more detail behind where that growth and demand is coming from and, again, to give you some ideas of where Flowserve is heading in these particular areas.

Supply, obviously, Middle East and Africa, a big portion of the supply, and this is incremental supply, as well as China. And you see Eastern Europe there again with a lot of finds now that they're suspecting are there in terms of shale, as well as on North America. Again, same thing here: This will be unique to see how the LNG market plays out. Countries that basically supplied gas in the past and turned that into liquefied natural gas may become consumers and vice versa if you begin to look at these changes in the landscape in terms of natural gas.

I think the other thing maybe to take a look at here. If you look at -- it's working now.

If you look at the power market, again, you see increases over this 10-year period in the power market. Incrementally, the demand, again, it's kind of a recurring theme here, that demand is coming from China. Demand is coming from rest of Asia, in many of these cases. The interesting thing on this chart is you begin to see, in Europe, some of the reductions in the use of oil as a way to meet that overall demand. You see there some of those reductions. So you have an ebb and flow here relative to retiring of plants, maybe some of the plants that have used oil in the past that have been expensive and maybe overall, lower efficiency overall in the plants and replacing those with higher-efficient units as we go forward.

Incrementally, if you take a look at the overall supply. Again, we've heard a lot of talk about coal. Coal still is a predominant supplier around the world. It looks like it's going to be here for some time to come. However, we do, obviously, see growth in the gas, nuclear and the renewables particularly in the solar area over this time. But you see from this chart here, coal and gas will still be quite large players.

The nuclear business, for all practical purposes, will, is targeted to grow. We still have, while we've seen several announcements of countries getting out of the nuclear business in the last 6 months, we've seen also endorsements, people still staying in there primarily because of the mix. A lot of countries want to have a mix of coal, natural gas and nuclear and also want to delve into the renewables and that particular areas by having a balanced mix.

In the chemical market, again, here, you see the growth, 900 metric tons going to almost 1,500 metric million -- million metric tons of demand. You see, incrementally again, the growth coming from China, rest of Asia. And again North America, possibly now -- due to some of the shifts maybe that -- what we're seeing in terms of the shale gas plays and with the projections going out further in this particular area.

Supply, again, China and Middle East has the biggest supplies. We've seen in Saudi that the Saudi has announced that they want to become a organization that's recognized for a petrochemical business, abundance of natural resources to provide feedstock for those chemical plants, gas, one, being one of the feedstocks. So they have good feedstocks to power the plants as well as to have for infrastructure, which makes it kind of a natural evolution for them.

The desal market, we've talked about that in the past. Again, overall good growth in the market, I've shown you some of the capacity numbers there. You see again million meters cube per day as the units. And over the next 5 years, you're seeing pretty astronomical growth in terms of the overall capacity in this particular area. Keep in mind that one of the major contributors in a desal plant is the amount of power being consumed, so that is, that will be an important factor in terms of the overall efficiency, which was one of the reasons why we purchased CALDER a few years, it's because of the energy recovery product that they had overall in that market.

I listed here the various projects that are being done around the world. And again, it's not surprising that many of the desal plants are in the Middle East and the rest of Asia, but you can see the split that there are planned plants around the world that, even in some of the developed countries like North America and, certainly, Europe.

So I'm kind of trying to summarize those last 5 into 1 slide here. Basically, you can see the bulletized areas, and again, this represents capacity expansion here. So the oil and gas, China and the Middle East in terms of where the capacity expansion is going to come from. Power, a little bit more mixed, where you have a lot of capacity expansion coming in China, North America and Europe. And then don't forget the shifts of the capacity expansion as some of those plants are being retired and put in service for maybe higher-efficient and different type of fuel source plants.

Chemical business, much of the same, driven out of China and Middle East. You see India come into play here, as well as the rest of Asia being capacity adds in the chemical market. And then, within general industry, I've called out one area here in terms of mining because it's varied across many different industries. Again, a lot of emphasis, again, same areas: China, India and Latin America. So it's not surprising when we take a look at our plans going forward into the future, as Mark has discussed, a lot of movement going on in the emerging markets as we prepare for these type of capacity expansions going further and, again, not at the expense of the developed regions but preparing for these with our Quick Response Centers, with our manufacturing footprint where we're, our resources are located around the world. And I'll show you how all that is coming together in terms of an integrated plan.

So the themes for 2011, I would summarize it basically this way: The long cycle business has been competitive and will be competitive. I mean, the competition in the long cycle business doesn't go away. It may change depending on the capacity in the business, and we've talked about that in the past, but the basic competitive nature of these particular plants will be there. The capacity begins to change that shift, and sometimes you will see schedule becoming much more critical or lead times. Especially if there's been a lull somewhere in the business, then the lead time will pop out as a maybe more of a driver, depending on the time frame that we're in.

A lot of -- very good improvements in the short cycle business particularly in the oil and gas, the chemical and the GI, so we've had good traction there. On the chemical business, what we saw is a lot of work going on in MRO. The smaller capacity increases. Not as many new chemical plants happening certainly not in the developed regions, but what we saw is small capacity increases in those regions and we also saw good petrochemical plants being expanded, as I mentioned before, in the Middle East region and in China.

Certainly, our QRC networks, as I indicated, are going to be a theme. You're going to see it over and over again in our particular process. The aftermarket business, that 40- to 50-year life of the product is a attribute that is significant in our business. And we have the assets planned and we have assets on the ground in order to be able to go after that business.

I'll speak more about the operational excellence, will be key. On-time delivery, quality, the 2 basic components that distinguish us for the business. Even though they're basic, the product has to work, it has to get delivered on time and has to work the first time. If we can do that then in this business that has products and services, then we're going be able to prepare and have a very good, sustainable business model going forward in the future.

So just a few words about the organizational structure. As Mark mentioned, we've had a change, with the COO coming into the organization, as Mark has mentioned. What we're going to do is, as we drive to this One Flowserve approach that you've seen from over the years, we're going to try to set up these product platforms, which are what you see here.

Each of these product platforms is unique in its characteristics. The basic thing that we're trying to do is we're trying to drive a consistent theme across each one of these platforms so that we put like businesses and like technical platforms together to be able to drive a consistency within that platform vertically. We also, at the same time, want to drive consistency across the platform in terms of core processes. So for instance, every one of these platforms, with the exception of seals, buys castings. So across these platforms, I want to drive a consistent approach relative to castings, as an example, or a consistent approach in terms of how we do product management within a platform. I want to have a consistent approach about how we do that across the platforms even though it may be separate and distinct within one of these particular product platforms.

Also within these platforms, we have a, what's called a lead product organization and a secondary product organization. The lead product organization, you can think of as the house for the technology, the house for the overall manufacturing plant in terms of where products are going get manufactured around the world, the house for the supply plan in terms of which suppliers we're going to use and where we're going to use them around the world. It may have the metrics for how that particular platform needs to respond around the world in each of the different manufacturing sites. So the lead product organization within a platform will begin to drive a consistency for that particular product around the world in terms of products and in terms of manufacturing capabilities to get that efficiency overall in the business.

The secondary product platforms then will execute on those basic attributes that the lead product organization has set up. So lead product platforms, secondary product platforms that try to get the consistency across the businesses in terms of core processes.

The other thing I would mention, and here are, the other thing I would mention on the organizational structures is this represents a system and what we will be doing is putting together, in essence, a control system around this in order to manage these overall businesses from a management control system.

What I've shown here is just again some other key attributes of the platforms. Each platform will have its custom acquisition process, which will be unique to valves or unique to seals because the products are different in that regard and how they go to the market relative to those products, maybe a little bit different relative to the products. We'll have engineering for each one of the platforms. And for instance, engineering on a very custom-engineered pump is different than engineering, for instance, on a seal- or an aftermarket-type business.

Next slide. So this takes you through each of the different platforms here. You see here EPD, which is roughly about a $2 billion business, about 71% of this is in oil and gas. Custom engineered pumps and seals packages in this engineering, this overall platform called EPD.

Next platform, industrial product platform, roughly about $800 million in this platform. And again, about 63% of these bookings are spread a little bit more uniform between chemical, water and GI. A lot of manufacturing expertise will go into this particular unit.

And the Flow Control division varied across the different industries, pretty well evenly distributed here. And again, highly engineered valve as well as high-volume valves in this business, about as you see here, a $1.5 billion business.

So the next area is, again, strategic localization. You can see here, and I've mentioned before, that the emerging markets is playing a more critical role in terms of the overall demand. Here, the demand going from, you see here about a 65% drop and all the way down to about 35% in terms of the developed regions. And you see the pick-up in the emerging markets, shown to the right there, are the moves that we have already begun to make over the last couple of years in this area called localization. So you see the buildout of India, you see the buildout of Brazil. You see us putting assets on the ground in terms of China. You see us setting up joint ventures in China in the nuclear side in order to get at this emerging market and the shift that we see happening.

Again, the overall footprint, 170-plus QRCs, Quick Response Centers, located around the world, 65 core manufacturing businesses. And again, your distribution is relatively, I would say, evenly distributed based on where the work is, with obviously more emerging market as we shift more and more of the business into the emerging markets.

Several of you have asked what a Quick Response Center here is. I've tried to be succinct here. I mean, basically, if you boil this down, it's a facility located near to a client or a cluster of clients to service the aftermarket, where technical specialists that can service them and anything from a 24-hour turnaround to something that may be several weeks in the making. We have pre-configured Quick Response Centers that we've set up. These things are not very expensive to set up. If we want a small one -- obviously, they're of various sizes, but that, this just gives you an idea of what these Quick Response Centers can be and what they look like.

Regarding the resources, I've tried to depict here over the last year the movements we've made. So 16,000-plus employees. What's shown here in the green is the growth that we've had over this particular time period, so you can see Latin America growing, Asia growing, Middle East, China, Africa, all the emerging markets growing in those areas. You see Western Europe, we came down in the resources there even though we did have a acquisition of Valbart, which is in the numbers there. You see North America growing, but that's due to the 2 acquisitions that we had there will Lawrence and FEDD Wireless.

Key priorities. Again, I will say here: Nothing out of the ordinary here, it just, it depends on the type of focus you’re going to put on these areas. So at the heart of this, quality and on-time delivery in the middle, aftermarket leverage and strategic localization surrounding that, and obviously the overall growth in the business with a focus, a relentless focus again on SG&A in a balanced way, along with product innovation, to drive the overall markets and products that we need to have.

So if we take a look at aftermarket, again, I would say we like the entire value chain. We don't distinguish between customers that want to buy parts and customers that want to buy an asset management business. We like the entire value chain, but more and more, the market is moving towards the right.

What I've shown here -- we've asked, several of you have asked questions in terms of taking it, "Show me what the operating costs are over the life of a pump." What I've tried to show here is, for a $10 million OEM pump cost, there is roughly $90 million of operational cost over the next 40-year life of this particular component made up of energy costs, maintenance, loss of production because the pump may be down for servicing and so on and so forth. This $90 million is what the customer end user sees. This is where our asset management is focused in on, in this $90 million worth of operating costs over this lifecycle. And if you can think of all the projects that we now do, you can get an idea of why we're so relentless in terms of our aftermarket.

I've just broken down here just briefly the overall pump costs to show you the amount of packaging that we can do with a base pump cost here. So you see, while it can range -- you see the ranges here. If I take a look at a pump base cost of about 60% of the total made up of the pump and the engineering and certainly the project management, which are key, we could have buyouts ranging almost 40% and, in some cases, going up to 85%, depending on the product. So it just gives you an idea in terms of how the costing is built up on one of our products, and this is variable. So this, we have a lot of different products and these take on different attributes.

So growing the market is, the aftermarket is critical: 171 QRC locations servicing this $1.8 billion business over the last 12 months since Q3; 450 global customer alliances, and these are primary, secondary and fee based. I've given you the fee-based alliances, over 110 fee-based alliances variable between the U.S., Europe as well as Asia.

Quality. A relentless approach to quality here. You see almost 1,600 trained Black Belts, master Black Belts, Green Belts working on over 1,000 projects in any one year. Most of the organization has been trained in awareness training in terms of what quality is all about and what we want to be able to do as an overall business culture. And I've provided you here one example of the 1,000 that just shows you throughput in the facility where we've got more throughput for less cost in terms of kilowatt hours electricity consumed by that facility.

Quality. Again, a lot of companies track scrap. We work in warranty cost. This is about looking at the entire cost in the organization. All the hidden cost: the documentation cost, the engineering cost, the cost for extra meetings because there may have been an issue, we're going to be relentless in looking at the whole pie here, the whole iceberg, as depicted here, to get at the overall quality in the business, which is what our customers demand.

Supply chain. Again, a lot of questions on, "What does your supply chain mix look like?" I've kind of depicted this here, typical supply chain. Obviously, mostly castings. We do a lot of motor buyouts. And certainly, outside machining are the 3 biggest components here. And in relative terms, I've showed you the low-cost country spend. I've mentioned previously that the valve FCD organization has been around 35 to 40. Here, you see the differences between them and EPD and IPD and what this represents as opportunities. It also represents different types of businesses that have different requirements and characteristics, but the low-cost country spend does represent an opportunity as we drive those businesses forward.

Research. About $35 million, we spend on research a year. Most of it goes into new product development, enhanced standards, which are very much sought after by our clients, as well as advanced materials. We do, do a lot of product development under the umbrella of actual contracts. The way we do our business is just an attribute in the business, but this gives you the overall split.

Capital spend. Again, 40, roughly 40% going for footprint expansion. Quick Response Centers, capacity adds are in the biggest chunk. You see renewing and replacing existing machines overall in the business to try to get more efficient. And as you've seen financial slides in the past, our capital spend has been very consistent over the last several years where we reinvest a lot of money back into the business, based on this typical distribution.

Growth is another key attribute, as Mark has mentioned. Again, a lot of emphasis in terms of the acquisitions that we're making, all done for different reasons. So CALDER, done for energy recovery; Valbart for the oil and gas transmission business; Lawrence Pumps in terms of chemical and oil and gas; FEDD Wireless, used on the aftermarket service side; and EMCOMET in Latin America, on the aftermarket service business.

So in terms of, I would say, the Flowserve difference, a lot of emphasis on knowing the customer and knowing the markets, knowing what the drivers are. Product development is key, and technical knowledge on our products relative to the customer as that you saw previously. On-time delivery, quality are a must in our particular business and also a distinguishing factor. And certainly, last but not least, the globalization and localization of our asset base are all mixes that come together.

Those mixes result in a target that we're going after: $6.5 billion to $7 billion over the next 5 years that you see here made up of a number of these levers that we believe can generate between 8% to 10% CAGR growth over this particular period.

So would you like to take a break? Okay.

So just a summary here. I would say, again: OEM equipment driving into emerging markets; the aftermarket model, which we've seen; on-time delivery and quality; as well as organic growth; and lastly, product innovation. If we can do all these things, then I think the growth you see on the other page of 8% to 10% is accomplishable.

Okay, so why don't we take a, say, a 10-minute break and come back around 1:45, please?


Mike Mullin

You all right?

Michael S. Taff

Yes, I got it. Okay, we'll get started again.

Yes, good morning. And my name's Mike Taff. I am the newly appointed CFO, I think 12 days and about 3 hours on the job. So my only advice to you is, if you ever want to be a CFO of a public company, don't join 12 days before the Analyst Day. But it's been a challenge, but it's been fun.

A little bit of background. I met a lot of you guys and some of you I've crossed paths in my prior life at McDermott and Babcock & Wilcox. So I was there in the last 7 years, 5.5, 6 of those as CFO. I went with B&W in the last 1.5 years when we spun off from McDermott. Prior to that, I spent about 10 years at Philip Services Corporation, a couple of years at British Petroleum, and I started my career in public accounting with Price Waterhouse back in the mid '80s.

I've had a lot of questions over the last 3 or 4 weeks about, "You promised us that you're going to take a year off and work on your golf game," and I certainly promised that to my wife and kids. And that didn't happen. And so, and a lot of questions today about why Flowserve, and really, "What are your initial perspectives?" So before we get into the slides, I'll give you that.

I think the easiest way to answer both those questions is tell you why Flowserve and probably 4 primary reasons why I found this opportunity to be very intriguing. The first, absolutely, was Mark Blinn and the management team. I had the chance to meet obviously, with Mark, a number of all the senior management team; Dick Guiltinan and all of his financial team, they really have open access; and met several Board members, and I just felt the culture and the integrity. The way Mark ran the business, the way Tom runs his business really fit very well, reminding me a lot of what we did at McDermott, reminding me a lot of the way Bruce Wilkinson ran the company there. And then for you guys that knew Bruce, first-class guy and a 25-year-veteran CEO of a public company. That's number one.

Number two is really Dick and his financial team. I did not want to go somewhere where I spent the first year, 2, 3 years organizing, developing and just doing the basics of a financial staff. Dick has assembled a first-class financial team, a lot of credit to Dick and to Mark and to that leadership. And what that will allow me to do really is twofold. I mean, obviously, doing those things are very important, having a strong internal. Don't think I don't take that seriously. I do. I'll spend time doing that but with a foundation in place and having a best-in-class finance team. It'll allow me to do 2 things in the first 12 months I'm there. It'll allow me to focus on operations and learn the business, work closely with Tom and Mark and try to bring some of the experience I had at McDermott and B&W because I think there is close alignment there on the operations side: get the operators to think as much about the balance sheet as they do the income statement, get them to work with them on how we go to market, how we bid, understanding risk management. At McDermott, we were really big on risk management. I want to make sure I bring that experience here. So we focus on risk management from the day that we bid the project until the day we ship the project, and by doing that.

And the second area I'll be able to spend a lot of time on is really what I'd call the financial stakeholders. And that's really the shareholders, prospective shareholders, our analyst community, investment bankers, commercial bankers, security providers, all those financial shareholders. I'll be out, I'll spend a lot of time with you guys, I'll be available. And with having that strong financial team in place in Dallas will allow me to do those 2 things.

The third reason I came here is I thought it was a good fit. I think the experience that I had over the last 7 years flows well with Flowserve, as Tom just went in detail with the business. The customers I'm used to dealing with is the same customers we have here at Flowserve. The end markets are basically the same in oil and gas, power, chemicals. The geographies are very similar to what I've dealt with the last 7 years. And so I felt very good about that.

And probably, last but very important, they're all important, but the last is opportunity. I came here for the same reason you did, and that's really to create shareholder value and, ultimately, make money. And I saw, when I did my due diligence and I talked to a number of people about the organization, about the people, about their markets, about their reputation, I see probably 4 areas where we can create value here.

Tom, you've seen it and you'll see at the end, don't flip ahead and go to the guidance slide, but you see where we, we're looking at top line growth, 8% to 10% compounded annual growth rate over the next 5 years. So I feel we can add value by developing the top line.

Tom talked about operational efficiencies. I think there's certainly margin enhancement opportunities as Tom gets involved in the other side of the business and we improve our operations, we improve our speed to market, we improve our quality, all the things he talked about. That will add value.

The third area is cost containment. We will address cost both on the operations side and the SG&A side. You'll see the targets that we've identified on the SG&A side, that will add value.

And if we do those 3 things and I do my job as CFO, we'll add value to the shareholder. And I think we'll get margin, multiple expansion as well, and we'll talk about that.

So the things I'm going to address today is what I'm -- I mentioned the financial team. I don't have a slide on that, but again, it's very important. And it's not just 1 or 2 people, it's really the whole organization. Dick's created a strong internal audit function, internal controls function, financial reporting function, operational accounting function. All of that goes hand-in-hand to providing a strong financial organization. And I think, when I think of Dick and what he's done here over the last 7 years, he certainly has done what we all want to do when we come into an organization and leave. He's left this organization in much better shape than it was when he arrived. And so Dick, thanks for handing me a first-class organization.

I'm going to cover our financial performance, and although Mark's touched on it some, I'll touch on it a little bit more. I'll talk about our bookings and backlog, our performance versus peers. You'll see different metrics, EBITDA multiples and then I'll also show you comparisons using our ROIC, return on equity as well as RONA.

I'll talk about our commitment to working capital and really what my priority is going to be during the first 6 to 12 months here related to working capital. We'll talk a little bit about foreign currency and exchange impact. And then last, we'll talk about guidance and driving shareholder value. So hang with me, don't swift, don't flip to the last page, and there's a story to be told.

So as we look at sales, it's a good story. If you look at 2011, as Tom had in his slide, we're going to end the year at roughly $4.5 billion in revenues. That's near record levels. And in our forecasting, as you've already seen on the guidance slides, because I have confidence you've looked there, that we're forecasting a 5% to 7% growth in the top line there.

Over the last 8 years, we've had a compounded annual growth rate of 8.2% so history says we can do this. We -- as Mark indicated earlier, 12% growth year-over-year from ‘10 to ‘11 and also achieving an 8% to 10% compounded annual growth rate over the next 5 years is not something that the organization hasn't done before.

On the margin side, you see we're creeping up close to that 14% level. If we do the things I just talked about, those 3 things I mentioned, grow the top line, certainly get some absorption credit there, improve our operational efficiency and improve our cost control, we'll drive margins up. And so you'll see, our commitment and what we're striving to do over the next 2 to 3 years is grow that margin 150 to 250 basis points. That's basically taking that 14% and taking it to a 15.5% to 16.5% over the next 2 to 3 years.

Let's look here at our end markets we serve and our bookings. A couple of things I'll highlight here. One is, for 2011, our bookings increased 10.2% versus 2012. Also, you will see here, as Mark talked and Tom as well, a shift in our bookings to the emerging markets. An increase in bookings in each Asia, the Middle East and Africa. Our short cycle business has also been very strong in chemicals, general industry and oil and gas.

And we do some of the things we've talked about, that both Mark and Tom have talked about, how we go to market. Over time, you can't help but improve the quality of that backlog. And I think what you'll see is that we get better bidding discipline and we've put in place some of the procedures and controls that Tom talked about. You'll see, over time, that margin and the backlog improve. Now I will tell you: Don't expect that to happen overnight. It's not easy. And we do have some past due backlog that we'll be rolling off during the first and second quarter, so that will hamper margins short term, but long term, I think you'll see some improvement.

This slide talks, shows our backlog. Mark mentioned earlier a strong backlog. We ended the year at $2.7 billion in backlog. That's the highest year-end backlog since 2008 and a 5.6% increase over the prior year in ending backlog. You will notice that on the right part of the slide, in the pie, our backlog is split: 76% OE and 24% aftermarket.

A very interesting thing that Tom talked about was just the volume of our revenues on the aftermarket. If you look at our sales mix, it's much different. It's actually 60% OE and 40% aftermarket. So what that tells you is that, in a given quarter, we've got a lot of what I call book-and-burn. We've got a lot of aftermarket revenue that comes in and out in a given quarter. It never hits backlog, but it's that recurring, high-margin profitable sales that runs through our system.

I mentioned earlier SG&A. The company has done a, just an outstanding job of addressing that over the year. Over the last 5 years, we've improved our SG&A margin 560 basis points, you see in this slide. Mark talked about the realignment, and we've spent about $90 million over the last 3 years and that process is essentially complete. We expect that to yield about $120 million annual benefit, going forward.

And then the gold bar is really our target. Our target, going forward long term, is an 18% SG&A run rate. That will yield somewhere in $20 million, $25 million of additional profit a year if we can achieve that. Again, it's not easy, but it's something we will focus our attention on and it's something I think we can drive to over the next 2 to 3 years.

This slide just kind of pulls together the things I just talked about and a couple of things I'll just highlight on this slide as it shows the last 6 years of financial performance. One is, and Mark talked about this earlier, solid financial performance through this last cycle. If we look at the last 4 years, in each of those 4 years, our minimum operating income was $580 million, so a very good performance not only at the top line but also bringing that to the bottom line with very good margins.

We did improve that SG&A line with cost management and as part of the realignment. That's a good story. I've mentioned our backlog rate, over 10% improvement year-over-year. And look at our tax planning. We don't talk about that a lot, but again, that goes back to the organization that Dick has created. We've invested a lot of money in tax planning strategies and also human capital, and that's really paid off. Look at the last 4 or 5 years: Our tax rate's been in that 25% to 28% range. And that, again, is not easy. It comes with a lot of planning, a lot of effort, a lot of working with our operations, with our legal group of how we set our organization structure up to achieve this tax. And at the end of the day, that reduces our cash tax, as you'll see later in the slide when we talk about free cash flow.

So in the next 3 slides, I'm going to talk about our performance versus our peer group, as I mentioned earlier. This first slide touches on EBITDA margins versus our peer group. What you will see here is, 4 of the last -- 6 years, we beat the peer group. And over that period of time, we've improved our EBITDA margin 580 basis points versus the peer group has improved theirs 170 basis points. So certainly, a good story there.

And then when you look at our performance on a return basis, on an ROIC and return on equity on this slide, on the left part of the slide, under ROIC, again, the last 5 years, we've outperformed the industry peer group. And certainly, in each of those years as well, an important factor is we -- our returns have exceeded our weighted average cost of capital. And then on the return in equity, again, in each of those last 5 years, we've outperformed the peer group.

In the last slide, the last metric where we, how we measure ourselves is on return on net assets. Again, last 4 years, we've outperformed both the high-performance peer group and our industry peer group benchmark in each of those last 4 years. And one thing I'd point out is that, from an incentive standpoint, senior management is compensated our LTI target based on a "return on net asset" performance versus the high-performance peer group.

The next slide, I want to focus on a lot because I really -- when I judge the strength of the company and its ability to both invest organically and inorganic, as well as return capital to shareholders, it really starts, in my book, with free cash flow. And when, it is really good story here, when you look at the last 4 years, we've generated in excess of $400 million of free cash flow in each of those years. That allows us to invest in the business both on an organic and inorganic circumstances, as well as returning capital to shareholders. And you saw that return of capital to shareholders that Mark mentioned earlier.

In some of the things that we've done. We've increased our investments in emerging markets and aftermarket capabilities. We've made strategic acquisitions, and Tom went through those and Mark did as well. And I mentioned earlier, we have invested significantly in our tax planning area. And that, if you look at the chart on the lower left, that shows the cash taxes. And that's a big benefit to generating free cash flow.

How we deployed our capital over the last 6 years. We've spent about $600 million in capital expenditures. That's a little north of our annual, on an annualized basis, of our depreciation rate. But as Tom showed you the breakout of capital expenditures, a significant amount of that is not only what I'd call maintenance capital but it's also growth capital.

We've spent about $779 million on share repurchase and dividends in that period, 220 of that in 2011; almost $300 million in acquisitions; and $229 million in pension contributions. Now we'll note that, for 2012, we're estimating our pension contributions to be around $20 million to $25 million. In effect, we're fully funded from a PPA standpoint beginning of this year.

The strength of our balance sheet kind of remains the cornerstone. It's something I believe in. And if you followed me, and I know a few of you guys used to give me a hard time at my previous employer about the strength of the balance sheet and the amount of cash we accumulated, I think it all starts, in an organization, with the strength of the balance sheet. So that's something, as when I met with the board and Mark, I said that's, one of my chiefs job is to make sure we protect the strength of our balance sheet. It's not that we're going to overly conservative, but keeping this metric in place is very important.

So we've set a long-term metric of, a gross debt to capital remains in that 25% to 35% range. And you can see in the chart here, we've obviously exceeded that over the next -- last several years. And we're going to end 2011 with about an 18% gross debt to capital and a net debt roughly is this 6% or so.

What that allows us to do is to be aggressive when it's time to do both organic and inorganic investments. The strength of the balance sheet will allow us to do that. Certainly, generating $400-plus million of free cash flow helps us do that, as well, but to have the flexibility in our balance sheet allows us to be opportunistic when those needs arise.

There's been a lot of questions, as I've read the transcript for the last couple of conference calls, on working capital and a lot of folks today have asked me about working capital. That will be one of my short-term initiatives and focus areas over the next 6 to 9 months. I will tell you when we've made progress. On inventory, if I had a bar up there for Q4, what that would show is that we decreased our past, our net past due backlog by about 20% in Q4. That's about $60 million to the good on a monetization standpoint. And if I -- and what I'd say is that, as we've looked at it, we've probably got another 20%, 25% to go so there's probably another $60 million, $70 million in cash out there that we can monetize by improving our performance on that side.

On the accounts receivables side, this bar shows a DSO north of 80 days. If I had a Q4 bar up there, it would probably show something close to 75 days. So that's an improvement of probably close to $100 million at year end. And what I'd tell you is that my goal is that number needs to start with a 6. We need to be in the mid-60s on the DSO. So there's probably another $100 million out there to be monetized related to the DSO on the other [ph] side. So I'll work closely with Tom's group, with the operational finance guys. We'll put in some metrics in place and incentives in place and we'll drive these 2 areas over the next few quarters.

Next, I wanted just to touch on currency and currency management and really how we address this area. When you look at the pie chart here, interesting statistic is that 2/3 of our revenues is translated into U.S. dollars from non-U.S. dollar reporting entities, the largest being the euro. Now, that 36% in the euro is not necessarily our exposure to Europe. That's basically contracts we have with customers in Europe and other countries and also it's much less than the 36% as it relates only to Europe, because we do work with customers such as in Russia and other countries that are euro-denominated contracts and all. So a stronger U.S. dollar versus the prior year results in lower reported revenues for us. What do we do? We basically -- we execute foreign currency hedges on the large contracts to lock in the cash margin at the project award date. Those foreign currency hedges are mark-to-market accounting each quarter and they flow through our other income line. And you'll notice the lower right part to the slide here, the notional value of those hedges. Those would not only include hedges that we have on contracts but also inventory hedges and some product hedges as well, some interest rate hedges and all. So that's actually the total of all the hedges outstanding.

So at the end of the day, our policy as it relates to this is that we basically want to manage that risk and have a strategy that will minimize the fluctuations in cash flow as it relates to foreign currency exchange rate movements, quarter in and quarter out.

This is a slide that I'm sure you haven't seen before, because you wouldn't flip ahead the deck on me, but this is our guidance slide. A couple of things I want to point out here: One, from an EPS standpoint, this is consistent with the press release that was issued back in December. 2012 EPS range $8 to $8.80. One footnote to note here is that similar to 2011, our 2012 earnings will be second-half weighted and margins will be impacted with the rolling off of some of that past due backlog in Q1 and Q2. Our revenue growth projection, as I mentioned earlier, is 5% to 7%. And the other thing to note is that with the dollar strengthening over the last quarter or so, we're going to have about a 50% impact, negative impact on EPS related to currency in the current year. We're projecting our CapEx budget in the $120 million to $130 million range for the year. I mentioned our pension contributions of $20 million to $25 million for the year.

Long term, I mentioned our guidance as it relates to operating margin improvement of 150 to 250 basis points and as Mark mentioned earlier, our commitment to return capital to shareholders, similar to what we announced in December, 40% to 50% of net earnings. So what's this mean to ultimately to driving shareholder value? The way I see it, if we can grow that top line as we talked about, 8% to 10% on an compounded annual growth rate, we achieve margin enhancements over the next 2 to 3 years of 150 to 250 basis points. That will obviously drive earnings improvement. It will increase our free cash flow available to share with, not only organic and inorganic investment opportunities, but also with the shareholders in the form of dividends and share repurchase. That will ultimately drive shareholder return and multiple expansion.

So thank you and I look forward to working with each of you in the future. With that, I'll turn it over to Mark for his final comments and Q&A. And as it relates to Q&A, there's a mic on the back of your chair, so once Mark basically recognizes you, if you can push the button on the back of your chair, it will activate your mic and everyone in the room can hear your question.

Mark A. Blinn

Thanks, Mike. Thank you, Tom. A lot of preparation to the team went into this, I want to thank you guys as well. And like Mike said, I do want to recognize Dick Guiltinan. Thank you for everything you've done the last 7 years. A real class act.

So look, I think just to kind of wrap it up and probably get to Q&A quick here. I think you've gotten the sense from my comments, from hearing Tom go through the details, the focus, Mike, where his areas of focus. That this One Flowserve approach -- bringing this all together is really what takes us to the next level and we’re looking forward to it. We’re really -- we like where we're positioned with our products, our geographic capabilities. And we think it really gives us the opportunity to capitalize on growth, and that's our focus. Our focus is on growth. We're going to look at high-margin segments, customized products. We're going to continue to tilt to the areas that give us good margin pull through in our business. Cost management, we're always going to make sure we focus on the cost line. And also, balance our customer base, have that geographic presence. You can see with our stable earnings, that's what brought us to the point where we are right now. And again, what I told you, it was a difficult, cyclical environment over the last couple of years. Focus on our balance sheet and cash flow generation and maintain that commitment to our customers and, of course, to our shareholders. So that's our focus: growth, return to shareholders.

So with that, what I'd like to do is get the team up here and let's answer some of your questions.

Question-and-Answer Session

Unknown Analyst

Mark, I was wondering if you could just touch on, you spoke about long cycle project pricing stabilizing. Maybe you could talk about how you selectively approach the bidding for some of these long cycle projects. If it's lower margin, how do you ensure you get the aftermarket? And how do you see the excess capacity in the industry sort of getting absorbed over time? How does that play out?

Mark A. Blinn

So the question, in case everybody didn't hear that, was around the long cycle, the pricing environment, how we're bidding it? How's capacity getting used up? How do we think about that? And I think Tom's slide, in terms of the total operating cost, is really how we think about these projects. So you go back to the Yanbu export refinery, the project that we announced last year. This is on the West Coast of Saudi Arabia. The reason they're building it over there is that they're trying to get assets away from the East Coast around security. So one of those things around energy independence and security. It's on the other side from Iran. You see what's happening in the Strait of Hormuz. So they're building a significant facility over there. We'd committed to put a QRC in place and so we got a substantial amount of the equipment. So that is a great example of how we think about the opportunity. Out of the contractors, I think 5 out of the 6 were Korean. It was very competitively bid. And so that was the environment where there was competition. You had to make sure you had great execution on your supply base. But I tell you, it was a low margin in terms of the original equipment. But we're going to plant the QRC there and we will be capturing that aftermarket for the next 40 to 50 years. So that's how we thought about that project. Now years ago, what I've talked to you about, at the end of '09 and early 2010, one of the things we had to consider was absorption. We have some large engineered factories around the world and you got to make sure that there's flow going through that. A lot of that we've been able to move beyond. We still consider that but that's some of the stuff that's still coming through right now. So in terms of industry capacity, we saw a lot of it come online because the investment decision from our competitors was made back in '07 and '08 and it takes a couple of years to get a large facility in place. We saw a lot of that come on really in 2010 and some in 2011. So there hasn't been wholesale incremental capacity that's been put on. So what you've seen is that capacity utilization is stabilizing and actually, over the year, it's come up a little bit. I don't know exactly what the percent utilization overall in the industry but the one thing that is going to drive additional capacity utilization is these projects going forward. I would tell you, the only thing that I see that is delaying that right now is everybody's watching Europe. And so you hear this consistently around industrial companies. These projects are going forward. The joint chemical processing plant in the Middle East is going forward. But it can push a couple of quarters as people watch what the folks in the Eurozone are going to do as well. So I think that -- it is going to happen. And we believe that while the industry is competitive, the capacity is going to start getting utilized. And also keep in mind, I just want to point this, capacity is not necessarily one size fits all around the world. We're building that facility in Brazil. That is dedicated for Brazil. The significance of that is they require local content on what they call domestic bid. So that capacity is important to be there because you have the limited ability to use capacity around the world. So when you look at capacity, we try to make it, for the lack of better term, ubiquitous where we can around our LPO/SPO strategy. But where we can't, we want to make sure we've got that the targeted capacity there. Does that answer your question?

Unknown Analyst


Unknown Executive

Good question. I mean, I look at 3 things all the time when I walk into the business. I mean, the first one is the on-time delivery, it's very important. I would say the second thing is the overall quality in the business. And then the third thing is what kind of management systems are you using to drive the overall business. I mean the -- I would say the weekly management cadence that allows you to have a view in terms of where the business is heading. Those are the 3 areas that I have spent my time over the last 2 weeks now in the pump side of the overall business. I would add, Scott, that we did start moving some things within the last 6 months. I mean the supply chain manager that was in valves went over and moved to that side of the house. So that's going to help on low-cost sourcing initiatives that we've been very successful out on the FCD side of the business. So we started that process. I would say of looking at many of the vendors and probably culling down the amount of vendors that we have in certain areas. A lot of emphasis on castings going forward because that's an emphasis that we put on the valve side. I would also say, one of the emphasis that we had that will be a targeted area is this whole area about manufacturing footprint and rationalization relative to where we make the products around the world. Capacity, having a good view about the capacity of the manufacturing facilities within that platform. And then determining, in order to best serve the client, where we want to have that manufactured around the world. So there's going to be a lot of emphasis on that there and I would say the rigor and rigidity around those particular items that I mentioned.

Mark A. Blinn

Scott, you know as well as others, rarely do I speak in absolutes. He will get it done. I mean, I have absolute confidence. This guy has already compressed 36 hours days into 24 hours for the last 3 weeks. Let me be real clear, he will get it done.

Robert Barry - UBS Investment Bank, Research Division

First, a couple of housekeeping items. The 5% to 7% revenue growth, does that include the currency headwind?

Mark A. Blinn


Robert Barry - UBS Investment Bank, Research Division

Or more than that?

Mark A. Blinn

Yes. The 5% to 7% is what we anticipate will be in our reported financials. The guidance was given on the currency rates back at the guidance time, so that will obviously fluctuate by whatever happens to -- if the euro goes to parity or the euro spikes back up.

Robert Barry - UBS Investment Bank, Research Division

So the currency adjusted rate will be higher?

Michael S. Taff

Yes. Absolutely, yes.

Robert Barry - UBS Investment Bank, Research Division

And then the long-term CAGR of 8% to 10%. Does [ph] the aftermarket, assume the aftermarket growth rate materially differ from that 8% to 10% CAGR, higher or lower?

Michael S. Taff

No, I mean you've seen roughly that CAGR, I mean, at that level. And so there is a breakout underneath that. But it's roughly the same. We want to go higher than 8% to 10%. But keep in mind, if we walk away from discipline, we can do that. But ultimately that's going to impact margins and chew up capacity. That's pretty similar to what we hope to see in the aftermarket business.

Robert Barry - UBS Investment Bank, Research Division

Just finally, on the goal of expanding the margins 150 to 250 basis points, I mean just based on what you see in the backlog now, based on the expected realignment savings, how much line of sight do you have to that, like a high confidence goal or is it stretch goal?

Michael S. Taff

Well, we wouldn't put that range out unless we believe we could meet it. I mean, if anything, over the last couple of years, we don't like putting anything out that we don't intend on meeting that obligation. And it is part of a longer discussion but really where it comes from, leverage on the top line growth. You've seen in typically in our higher volume quarters the type of SG&A leverage we can get in our business and we still have some work to do on the SG&A line. It is around overall backlog conditions improving in our business as well. One thing to keep in mind, as you look, the pricing environment that we saw in '07 and '08, remember Tom's slide on the buyouts and then you had the pump manufacturing? A buyout is literally where we go and procure a motor from General Electric or ADB. Your customer does not let you get 30% margins on that buyout because what they’d do is they’d say, never mind, I'll go and buy it myself. So I think what you need to remember is that in these big pump packages, where we really get our margin is on the pump manufacturing side but we have to take the whole thing through our P&L. I just referenced that so you understand that as we start to drive these margins going forward, improving it, we're always going to have those big projects that are in there. That's important to us. That's how we get a hold of our customer, in general. But it's going to be the fixed cost leverage. It's going to be the rigor and discipline that Tom brings to the business. And I'll just point you to one thing. Look at the valve business. It's got industry-leading margins. So what that tells you is you take a step back and you say, I look at the margins across our business, I see what he's done on the valve side. Clearly, there's opportunity overall in the business.

Unknown Analyst

Mark, can you gives us a sense, when we look at backlog and the margin of that product that’s rolling off -- the lower margin as it’

s rolling off for the next couple of quarters. Can you give us a sense of the delta or kind of margin headwind you're seeing relative to what's kind of in –- more newly booked into the backlog?

Mark A. Blinn

Well, let me just reference more the past due backlogs. With any project, time is not your friend. So the longer it sits there for whatever reason it is, the more cost attach to it. I think we've talked about this before. Once one of these projects gets down to where it's got negative margin, you have to take a lower cost to market adjustment at that point in time. So you can't just let that negative impact hang in there. But we've got some stuff that's going through and no margin in our business because time, delays, external forces, internal forces, whatever they may be, and so think about that business it's rolling through and how that will impact margins. Going forward, and I know you want us to talk about pricing specifically but what we're seeing is it's still competitively bid. There is some margin in these big projects, but there's not a whole lot, especially when you look at the whole value stream in terms of the buyout, the pump and everything like that. You're not going to get. Think about it, if 40% of what you're putting through on that large project has very little or no margin on it because it's a buyout. You're procuring it from somebody else. And you can get good margin on the rest of it but it's still going to have a margin profile and you see a lot of this in engineering and contracting firms. But what we do see is stabilization. We see, as capacity gets utilized, sometimes you don't have to take projects below your cost to necessarily make sure you're absorbing a factory. So I think that's what we're talking about. When you see pricing stabilize, what that does is that it starts to say you can drive some margin to your projects. As capacity starts to get utilized, you'll take it up. Now, again, what you saw in 2008, these people were giving you pretty much whatever margin you wanted to secure a spot in the manufacturing line.

Unknown Analyst

I have one more follow-up. On the QRC build out, can you give us a sense of what the QRC build out plan is and how much of the aftermarket growth projection is coming out of sort of new QRC versus kind of on a same-store sales basis producing [ph] infrastructure?

Mark A. Blinn

Just to explain again, it's not a retail model. So you won't hear us announce same-store sales in our business and in incremental growth, because every QRC is somewhat different. The one in the Middle East, you might as well just call it manufacturing facility. And actually we're starting to move manufacturing in there. But I think we've been putting in, Tom, about 8% to 10%?

Thomas L. Pajonas

Yes. About 8% to 10%.

Mark A. Blinn

We've been putting in about 8% to 10% a year. And again a lot of what we do is customer led. If we build a QRC out in the middle of Saudi Arabia and nobody wanted there, then it becomes a place to hang your coat. You really have to work with the customer to drive that. But we're looking to continue to add that. That's important but that's one of the parallel paths we pursue. Integrated Solutions Group, that's around using technology, FEDD Wireless, is really having that intelligence in the product itself and that's where you're seeing it move. Historically, when you looked at the intelligence in the control room, it was systems that had observations on the equipment and brought the intelligence into the control room. Increasingly, the intelligence is moving into the product, which we manufacture. And the communication of that is more ubiquitous, a handheld device. So the point to that is, that's important as well in terms of driving aftermarket. The video is the video, but if you listen to a lot of it, with these input costs and these facilities, they're looking to drive efficiency. So it's just beyond -- the QRC people typically will look at it as a repair center. And oftentimes, that's what it is. But there's much more to our aftermarket strategy.

James Foung - Gabelli & Company, Inc.

I guess [indiscernible]

Unknown Executive

I can't hear. Do you have a mic?

James Foung - Gabelli & Company, Inc.

As you embark on the new organizational structure, do you see any immediate margin gains from consolidating operations over the next 12 months?

Mark A. Blinn

The question is this new org structure, are there any immediate margin gains? I mean, there's going to be some immediate benefits of the rigor and discipline and the way Tom approaches things. But I think one to keep in mind, when we talk about new, we're not talking about hiring a bunch of new people into the company. I mean, this was really a strategic move around starting to consolidate some of the benefits we have from operations. Tom has a lot of good leaders within the organization. I think probably the biggest opportunity for us to improve, as we get through this past due backlog, is these folks are going to be energized as new leaders and going to be able to drive some change. That'll probably be the quickest benefit that we get. But he'll drive change over time, as you saw in the valve business. So this is not where something is fundamentally broken, and overnight, we're going to be completely transforming the business. There is clearly room for improvement. There always will be. But I fundamentally think, just the energy level and the discipline is what's going to provide us more immediate benefit.

James Foung - Gabelli & Company, Inc.

Just a question on tax rate, you've done a terrific job in lowering the tax rate in 2011. Can we see more reduction of tax rate as we go forward?

Michael S. Taff

I'll just tell you, I mean, Dick's talked about this before. The structural tax rate's roughly 28% to 29%. Our tax rate can vary notably, in any given quarter, depending on the percentage of domestic versus international revenues. So if you -- and I talked about the strength in North America. That'll tend to push your tax rate up because the marginal tax rate in the United States is 35%. So I think -- but the real issue is around tax planning, creating structures and, now also, really moving it into operations because a lot of the tax planning is not just what I'd call legal structuring or things of that nature. You can really get some benefit from driving it into operations. And that's some additional opportunity and that is creating sourcing centers and low [indiscernible] tax jurisdictions. Things like that, they can drive your tax rate down to provide us additional opportunity. But our structural rate, based on historical mix, is still in that 28% to 29% range.

Unknown Analyst

So can you give us an idea of what each one of your segments, in terms of capacity, is currently running at right now? And then you guys called out that we're going to see margins come back this quarter, maybe the first half of '12? Within 2012, where do you exactly see your margins start to stabilize at that point?

Michael S. Taff

I'll let Tom try to give you anecdotal information on the capacity in the 3 segments. Around the margins, what we've talked about is we still have to work through late '09, '10 past due backlog over the first couple of quarters here and that's going to put pressure on our margins. But what we'll see, probably a confluence of events, as we work through that past due backlog, that's more to the past, but also as Tom starts to drive the rigor and discipline, we get the revenue growth, so you get the fixed cost leverage. That's when we'll start to see the margins improve. In terms of stabilizing them in 2012, that's not our intent. Our intent is to grow our margins.

Thomas E. Ferguson

So, Bill, were you talking about industry capacity or the platform?

William D. Bremer - Maxim Group LLC, Research Division

I think it's capacity.

Thomas E. Ferguson

The full sort of platform capacities?

William D. Bremer - Maxim Group LLC, Research Division

Each one of your segments. What's the capacity [indiscernible]

Thomas E. Ferguson

I mean, first of all, when we talk about capacity, I think Mark mentioned before it's not a uniform view of that capacity because within each segment, you have manufacturing capacity in terms of, to actually footprint itself, you have engineering capacity, you have the third-party supply chain capacity, you have testing capacity. I mean all those things become a mix. And I know that you're looking for an absolute number but it is a very complicated mix. And then it goes, are we talking large projects? Are we talking the aftermarket? So, I mean, unfortunately I'm not going to be able to give you an absolute but all I'm going to say is don't just look at the manufacturing. You have to look at each individual piece and it's more meaningful if we had a discussion about just manufacturing or just testing or just engineering or just supply base. And then supply base, you've got to cut it down and say, what's the casting piece versus the machining piece? It's much more complicated thing, that's just a simple answer.

Mark A. Blinn

Honestly, Bill, when we look at the capacity, I think, always, one of the things we always keep our eye on and focus is engineers. We always need to make sure we've got good capable engineers because that'll slow down the process more than anything else. It's –- rarely is it square footage. It's typically do we have engineering capability, the program management, the project management, just around that discipline.

William D. Bremer - Maxim Group LLC, Research Division


Thomas E. Ferguson

As far as specifics, it's 12 days. It's hard for me to tell you exactly what we're going to do different. I think it's more -- what I mentioned is, it's more really an operational philosophy. What Tom and I will work together on is how we go to market? How we address the customer? Starts with the bidding and making sure we understand what the full cost is in each bid. Have a cash flow target. And then also, I mean, there are other places I've been where we, at a minimum, we wanted to be cash flow neutral throughout the life of the project and things like that. I mean so those are the type of things that we can look at and all. Every business is a little bit different, every market is a little bit different. But I think the important thing is that just getting in the operations mind and those guys -- in our salesman's mind, is that when they go to market, cash flow and working capital management is a very important aspect of the business and all. So it really gets more to culture. And I'm not saying it doesn’t exist here today. Again, I've been here 12 days and, obviously, about 11.5 of those days, I've been working to get this document ready that you saw today. So give me just a couple of more weeks to get through the quarter and the board meeting and get the K filed and we'll certainly have some little bit more detail.

Mark A. Blinn

And what I would add to what Mike said is a lot of it is in the core operations of the business. Getting the build materials right, so the vendors can ship the stuff back to us on time and there's no delay there. Making sure there are proposals, have cash flow, curves in them as we're bidding so that people know what they're being targeted when we get that particular job. Some of those basics, making sure that our engineering drawings are right the first time and we don't have to go back in. All those things have a -- those are the things that, as Mike has indicated, we tend to forget and look at more out at the financial side of things. Those are the things that make that working capital better, it's those basics.

Michael S. Taff

And Tom and I can from the same background. He spent a number of years in Combustion Engineering. When you're dealing with $300 million, $400 million, $500 million projects, those things are integral. And so we just need to take that same philosophy and embed it in the culture here.

Unknown Analyst

Another question on capacity, I apologize. But just thinking about the longer-term revenue targets you've put out for 2016, in regards to capacity, do you have the availability to achieve that today or maybe tell us about what the stress points are? You talked about some of your targets as far as expanding margin from here. I guess if you could kind of wrap that up, what kind of incrementals or incremental margins can we kind of put in that framework?

Mark A. Blinn

Well, in terms of our capacity, where we're going to need to add it is in the markets where our customers are primarily. I would tell you, there is, unless it’s a capability for a product. There is not a lot, necessarily in the mature markets. As a matter fact, is you look at our LPO/SPO, that's designed to create incremental, what I call, front end capacity in our future markets. But keep in mind, again, we said capacity is not ubiquitous but also capacity also can also be dedicated, not only from our standpoint but for the customer standpoint as well. So going forward, this local content, local employment is increasingly important in Saudi Arabia, India, China, Brazil, Russia as well. So our capacity will be really to address those needs or for example, when we talk about India, the easiest thing to do is build the brick-and-mortar. We've got a great team in India. We built Block 1 a number of years ago, Block 2. And we're moving on block 3 and it's really designed to address additional segments of the market, as you kind of migrate that under the existing management team. So I think, to kind of summarize it, yes, capacity leverage is going to be one of the drivers of our incremental margins overall in our business. We will work on creating additional capacity in our existing footprint, for lack of better term right now, through our LPO/SPO strategy, through some of our operational metrics and efficiency. We’ll always keep in mind on the engineers as well. I really tell you, I think that's the real capacity constraint, overall, in our industry. So there's an opportunity to leverage our capacity, but we also put it in place and maybe day one it’s underutilized. But we're also going to put it in place to address the markets and our local customers. But we're not out of capacity at this point in time. We have the opportunity to create more. Frankly, if you look at our slide through the last increase in the market, we didn't add a lot of square footage. We added quite a bit of revenue. Two reasons for that: One is some of you all will remember, big acquisitions back in 2000, 2002. We came into the cycle with excess capacity, but also we created more efficiency in the capacity that we had.

Unknown Executive

The other thing I would tell you is just relative to the base in the '08, '09 time period when we were building up. Predominantly coming in, we were running first shift and many of these facilities were able to go to second shift, third shift, increased the revenue just by adding the shifts in the basic hard asset that was sitting there. So you have that capacity and then, as Mark indicated, you may be capacity constrained in a particular area like a testing. So that maybe something where the facility is constrained, not by the brick-and-mortar but maybe by some other thing that we can lift that constraint but -- and get the full benefit out of that physical asset itself.

Unknown Analyst

You made a significant amount of investments in emerging markets. At what point do you start to realize the full amount of leverage, operating leverage, in those markets that exceed the investments that you've made? So I'm assuming that you'll start to see some significant margin improvement in outer years. How much margin improvement should we expect to see and when do we expect to see it?

Michael S. Taff

Well, that depends by facility. I mean, it depends on the region it is in and the facility. I can tell you when we opened our facility in China, there was not a lot of activity certainly first day. Even went there about 9 months afterwards, and it takes a while to ramp these facilities up over a period of time. You go back a couple of years later, it's full and you need to build additional capacity. When it's full, the moment before you go and make that investment in additional capacity, that's when you're getting the most leverage out of it at that point in time. So that's an example: one, where we kind of greenfielded a facility in that location. Go back to my India example as well, that first facility with the first management team is where we were getting the least leverage in terms of that incremental capacity. As we put in the second block, all right? It ramped up in terms of productivity fairly quickly, because we had the management team in place, the processes in place. It was just a matter of filling the square footage on and on in terms of Block 1 as well. In general, our new manufacturing in the emerging markets, you got to go case-by-case, Saudi Arabia is ramped up as well. It's not full, but it will be, and we have the opportunity to expand behind that. Our new Brazilian facility, we have a facility right now. It is somewhat limited because it's sitting in downtown Rio, but as we build our new one in Campo Grande, not only can it take additional products. It has additional crane-age, additional test, but we'll start ramping that up. We expect to finish that here over the next couple of months and get it into service. Now, there'll be some initial inefficiency because we're going to be running 2 facilities, as we migrate the capability. I don't want to take you all through this one by one, but the point is, I’ll go to go back to this. We don't make widgets. Our capacity’s not ubiquitous. So you don't want to look at us like the automotive industry, where you just -- everything is the same in terms of capacity. Every square foot of capacity tends to have a different story and that's because of our customers, our capabilities and our products in the markets we serve. But those are a couple of examples. I think we're starting to build some service capacity in Russia. Over time, that will probably be demand manufacturing there as well. Right back to Jamie. You can scream if you want and I'll repeat it.

Jamie Sullivan - RBC Capital Markets, LLC, Research Division

[indiscernible] What historically your capture rates sort of run? How you feel that's trending today? And as you think about 2012 with the installed base growing, what the relative opportunity is coming off of warranty, say, versus 2011?

Mark A. Blinn

Okay, so the question is kind on the capture rate on the aftermarket and how we see the new installed base rolling off that we put in over the past couple of years. The best example of high capture rate is our seal business. It's very high capture rate. It's basically the seals, that's an aftermarket business. Because the mean time between failures are so short, you have the drawings, you have the capability, you can respond very quickly, sometimes within 24 hours. And if you think about it, a pump operating, if the seal is not operating well, you got to take that pump out of service. So I think that's the first one, very high capture rate, around 90%. We haven't looked at it in a couple of years, but we were in the 30% to 40% range in pumps and valves. I'm confident that's come up, not only because our ability to respond, but moreover, this equipment is getting increasingly complex. And if you think about on your automobile, if it's a very complex automobile, you really want to think about who's servicing that equipment. They have the capabilities, the drawings, and -- so we've seen that attachment rate go up. But a lot of that is, at the end of the day, that aftermarket won't attach unless we take good care of our -- unless we're there for them on the project and also we take good care of them through the entire process. In terms of incremental install base, I think we've, over the last couple of years, we've started to see the benefits of the market back in '07 and '08. But one that's still yet to come is the one I talked about, Yanbu export refinery. We get that built and we'll be sitting there taking advantage of that aftermarket capability. There's a number of other projects. We go project by project of things that either had been commissioned and haven't gone out of warranty. Warranties can be, generally, one year. Maybe 1 to 3 years, those are oftentimes negotiated. Just keep in mind, it's not that there's no aftermarket business during the warranty period, because I can assure you, sometimes bricks, hard hats tend to go through the process and it needs repair or it just -- didn't operate it right or they need more efficiency. There's things beyond warranty that can cause a system to need repair.

Unknown Analyst

Then just a quick follow-on if I might for Tom Pajonas, just some of the EPG that talks a little more about their order dynamics, where they’re seeing few of the lump-sum turnkey, maybe more of a phased-in approach. Just wondering what you've seen in terms of the size, timing and bookings dynamics for Flowserve if that's had any impact?

Thomas L. Pajonas

I mean, over time, the fixed fee and the reimbursable are going to shift depending on the business. I mean, most the time -- it depends on the market. In the power market, you have more fixed fees on the EPC side. It's just a characteristic of the market. On the oil and gas side, they tended to be more reimbursable overall. When you're putting a power plant in, a coal-fired power plant, most of the ones that I've ever been in, involved with, have been fixed fees. I think it's more dependent upon the industry and I haven't seen any radical changes. Although I've heard more movements potentially going away from reimbursable, more towards some fixed fee. But it's just some inklings that we've been picking up over the last 3 or 4 months and nothing really that I could say is definitive.

Unknown Analyst

The 6.5% to 7% organic growth forecast through 2016, that's about 60 to 100 basis points above the addressable market growth rate. I'm just wondering, what's the biggest initiative driving that delta? And then how does that compare to what Flowserve has done historically and what opportunities, in terms of market share gains or anything like that, has changed to, I guess, help or hurt that opportunity?

Mark A. Blinn

There's a number of initiatives to drive that. One is going to be strategic localization. That's around being present where the opportunity is, so you capture 100% of the opportunity not just your proportionate share necessarily. I think one of the keys is going to be around execution. And remember the comment I made earlier, time is money. And so if you can shorten lead times, deliver on-time and then provide the quality, then customers will tend to tilt to you because the piece of equipment that doesn't operate the way they want it to is the most expensive piece of equipment that they'll buy. So there's a whole set of initiatives around -- I mean, literally, we do have, in our strategic deck, a whole set of initiatives around capturing market share but being disciplined. Again, that number around the market share gain could be adjusted higher if we weren't focused on margins. So I think, and if you look historically, we were able to capture market share. And I think it was in the similar amount during the last boom. Everybody was -- but I don't know that you necessarily gain share, frankly, overall in that market because the data didn't forecast how strong that spend cycle was going to be in '07 and '08. And frankly, the interim [ph] contracting firms and the end users, they were worried about capacity. And so you did have some differentiating factors but it wasn't going to be a lead time. Lead times were all moving out at that point in time. So what I try to say is, competition, it's a rising tide. Everybody's with you there in '06, '07 and '08. These are times, as you move out of what I'd say is a down cycle, these are times where you can really start to distinguish yourselves. Jim, I think you had another question?

James Foung - Gabelli & Company, Inc.

Just on acquisition. About 10 years ago, you made a big transforming transaction with the purchase of IDP and you certainly have the balance sheet to make another transforming transaction, but you've been doing bolt on lately. So just wondering if your appetite for acquisition is getting bigger, where you might do something like that? And also, what areas would you be looking at? Would you be trying to diversify your energy exposure as you look at acquisitions in the future?

Mark A. Blinn

Question’s on acquisition. Just to probably reverse the question. I mean we don't let the size or the capability of our balance sheet drive our M&A strategy. And that's just not the right way to approach it. It has to be your strategy, the product gaps, the opportunities that you have, the ultimate ability to drive shareholder value and then your financing decision, your balance sheet tend to be the last things that you consider when you look at that. As we look out there right now, I mean 10 years ago, it was acquire or be acquired. It was a different environment at that point in time. Mario, I know you were there at that point and you saw that point in time. It was fragmented and you had a choice. So I would say your strategic options were far, far less than they are these days. Now we’ve built much more critical mass, more geographic presence. Remember, some of the entities were more Europe focused at that point in time than U.S. focused. It was a different period of time and it was transformational. And then the IFC acquisition was more oriented around bringing flow control together around the valve side. So it was really a different strategic approach. Now, as we look at opportunities, what we're really looking to do is say, how can we capture more of our customers' wallet and leverage our existing platform? And that's why we talked about we like to these bolt ons, when we look at acquisition opportunities. But a bolt on can range certainly in size. But our focus is going to be really on our global customers, our customer base, how can we take better care of them, what else do they need from us as well? But the key is it's got to fit in to our core competencies. It really does. One of the things you look at as a core competency is hydraulics, rotating equipment, static engineering, engineering capability, efficiency and upgrade, global sales. Those are the things that when you look at our acquisition opportunities, and you also want to make sure that you pay a reasonable price so you can get the internal rate of return on your acquisition opportunities. And so at this point, what we've talked about is, that we really like these bolt ons. These are the kind of acquisitions where you can take a $5 billion business and really lever it, double the revenues over a relatively short period of time. If it's got a good product and a global opportunity.

Unknown Analyst

Actually, a follow-up on that question. I mean, on average, you've done -- it looks like about one deal a year over the past decade or so. Is that kind of the pace that we should expect going forward? I mean, how many of these Lawrence pump opportunities do you see out there? Then I have a follow-up on a completely different topic, which is nat gas. How much of your business is exposed to U.S. nat gas and how are the falling prices there impacting it?

Mark A. Blinn

We don't have a stated one deal a year policy. It's really going to be based on the opportunity out there and our ability to respond to it. And in terms of the bandwidth, so when we thought about Lawrence Pumps, we thought about what operation is that going to touch? Who's going to lead that? Do they have the bandwidth and do they have the capability? So we think across the entire value stream out there and in terms what we're going to be able to add to it, because we feel we want to get that IRR and getting the benefit out of it as quickly as you can on a cash on cash return is important to those internal rates of returns. So don't think it's one a year or any kind of metric like that because, honestly, if that's what we did, you’d say, are they really thinking about this thing strategically or are they just trying to have a discussion with you about an acquisition one time a year, which is not what we're trying to do. In terms of the natural gas, let me let Tom respond to that.

Thomas L. Pajonas

Yes. I mean, we do supply some of the valves primarily on the distribution side on the natural gas, not at the well head itself. And I would say, going forward in the opportunity area, if the abundance of the U.S. gas stays the way it is, you're going to be taking and probably creating LNG opportunities to take that offshore and ship it somewhere else. So there's going to be opportunities across that LNG market. If it becomes an export situation where, up to now, it hasn't been, but I think that, that could potentially switch given the abundance.

Unknown Analyst

For Tom, as you look across the –- and I realize it's early days for you in your current spot. For the 65 manufacturing facilities that you've got, I know you won't tell me how many things you can rationalize but as you look at the footprint, how many are being run, for lack of a better word, optimally? You got 6 sigma lean [ph] manufacturing. When you bought IDP 10 years ago, some of those plants were first rate plants, some needed more fixing up. Can you give us a sense of when you look at that footprint today, how much are essentially –- need a lot of fixing up, how much or kind of pretty close to being where you like them?

Mark A. Blinn

I guess, the way I would answer that is even a well-run plant, even something that's the best in the network, can always improve incrementally. So for instance, I think I reported this in past discussions here. In the '07 and '08 ramp up, we had very high performing manufacturing plants, say, on the valve side. What we were looking at is now a different level, because what we're trying to do is get a revenue efficiency out of those plants based on the driver that I needed at that particular point in time, which was more capacity out of that facility. So I would say, it's a never-ending issue that we're going to be dealing with across the entire network. Now, do we have some plants that are operating at less efficient performance than other plants? Yes. That's where the on-time delivery comes in. That's where the quality comes in, out of the plant. And a lot of it is basic, also. It is not some fundamental product development issue or something that can't be made on time. It's core supply chain management, making sure that the suppliers will deliver on time. It's core assembly and test, making sure the test facility is available when you need it to test. And if I have a shift of 1 or 2 weeks and a schedule for test, but yet the test stand is all backed up, then I'm going to start missing on-time delivery, albeit 1 or 2 weeks, it's going to affect working capital because I'm going to be sitting there with that inventory and so on and so forth. So a lot of it is really getting back down to the basics, meaning, have everybody in the supply chain deliver on time, have the engineering done right the first-time and deliver those drawings to the supply managers, so they can go get that product on-time. Those are the things we're going to concentrate on. I mean, the fact that facilities are fundamentally broken is not the way I see it. I see working back through those basics. We have the products. We got the services. We do have the capabilities in these facilities to manufacture the product. It's just reorienting and I think people, based on these 4 or 5 key attributes that we're going to drive.

Unknown Executive

As a follow up to that, for the operating margin improvements you guys have laid out, how much of that really is going to be coming from taking your manufacturing footprint and optimizing it better than where it is today and how much of it is doing other activities?

Michael S. Taff

The optimization is going to be a piece of it. There's many levers when you do gross margin that you begin to pull. I would say our LPO/SPO platforms will probably be dictated more about where the customer orders are coming from and what we need to do in order to be successful going after those particular orders. Then we'll begin to ship between where we manufacture in the LPO/SPO period. The other levers that we'll pull is we have specific pricing initiatives, where we're taking all of our products and we're looking at what are the attributes in the value chain that the customer is really buying in that particular product, to see how we can maximize that particular piece. The supply chain, I would say the supply chain is an area right now that has a lot of opportunities. When the supply chain was built up in '07, '08 and '09, you started going to third-tier suppliers in order to fill the capacity that was needed overall in the industry. When that began to dry up in '10 and when those units started going into service, I'm saying, collectively for the business, a lot of those third-tier suppliers had difficulty with some of their products. So now, they're starting to go away. So a lot of our effort is going to be around supply chain, supplier relationships, making sure that we give them the information that they need but we help them manage making the product instead of throwing them a drawing, what you see in a lot of cases, in the industry in general. A vendor is given a drawing. They're not coached through the drawing. Things are a little bit different on this one versus the other one and they make an error that shouldn't have happened. So again, supply chain will be a big component in that area also. We're going to look at warranties. We're going to look at the amount that we spend on scrap, rework. We've got a program going in place in terms of the amount of energy that we use in various facilities. That would be a piece of that overall, gross margin. We have initiatives in terms of throughputs with the facilities. As I showed you, we got 1,000 projects going on right now and I think I mentioned about 150 projects devoted nothing to cost reductions or we'll take a product like a pump or a valve, explode it out to all of its pieces and fundamentally start putting it back together again, looking at weights of each components in value engineering type processes. So we have a lot of those initiatives in place, but it's, I would say, it's probably 8 or several -- 7 core leveraged areas that we're going to go after.

Mark A. Blinn

We have time for one more, if we have one.

Well, thanks. Let me just summarize and make sure -- we want to grow this business. We want to be disciplined and profitable. As you mentioned on the -- we'll do it organically. We think we have the opportunity with the growth in the emerging markets, the aging infrastructure in the developed markets. We'll also look at inorganic opportunities. We'll certainly be disciplined. We don't feel defensive that we need to do anything, as you talked about. It's transformational like it was 10 or 12 years ago. I can tell you we're very glad we have those assets today. We're going to focus on growing our business. And then we want to leverage that growth. We want to leverage it in terms of margin, earnings and then, of course, those earnings will ultimately benefit all of you in this room, our shareholders, and we'll stay very focused on making sure we get those returns to you. So look forward to seeing all of you next year. I'm sure I'll see some of you in the meantime, but thanks for making it out today. We do appreciate it. We've listened to your feedback. Hopefully, we've helped you understand our business better. It is complex. But that gives us a competitive advantage, really, against other industries. So thanks for your time and look forward to seeing you again.

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