Good day and thank you for standing by. Welcome to the 2021 Flowserve Second Quarter 2021 Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your speaker today, Mike Mullin, Director of Investor Relations. Please go ahead.

Thank you, Christina, and good morning, everyone. We appreciate you participating in our conference call today to discuss Flowserve's second quarter 2021 financial results. On the call with me this morning are Scott Rowe, Flowserve's President and Chief Executive Officer; and Amy Schwetz, Senior Vice President and Chief Financial Officer. Following our prepared comments, we will open the call for questions. And as a reminder, this event is being webcast, and an audio replay will be available. Please note that our earnings materials for this call include non-GAAP measures and contain forward-looking statements. These statements are based upon forecasts, expectations, and other information available to management as of August 6, 2021, and they involve risks and uncertainties, many of which are beyond the company's control. We encourage you to fully review our Safe Harbor disclosures as well as the reconciliation of our non-GAAP measures to our reported results, both of which are included in our press release and earnings presentation and are accessible on our website at flowserve.com in the Investor Relations section. I would now like to turn the call over to Scott Rowe, Flowserve's President and Chief Executive Officer, for his prepared comments.

Great, thank you Mike. Good morning everyone, and thank you for joining our second quarter earnings call. We're pleased with the performance and solid results in the second quarter including adjusted EPS of $0.37, which represents a 32% sequential improvement. It reflects our continued transformation progress. We were encouraged by our bookings of $953 million, which is nearly an 18% year-over-year improvement. At this level, Q2 was a momentum-building quarter for Flowserve as our bookings inflected upward, and we now have a clear line of sight to earnings growth. The higher level of bookings and our improved operational performance have provided us the confidence to raise our outlook further for the full year. Our revised adjusted EPS guidance is now $1.45 to $1.65 for 2021. Since the start of the pandemic, we indicated that recovery in our end markets was expected to be directly correlated with the progress being made with COVID-19. Each country and geography are at different stages in fighting the pandemic. But on a global basis, a clear pattern has emerged. As countries roll out vaccines, COVID cases declined dramatically, and then mobility and consumption began to improve. This, in turn, drives customer spending for nearly all of our end markets. We are confident in our ability to continue to grow the Flowserve enterprise and ultimately restore bookings to pre-pandemic levels in the coming quarters. There are several factors that contribute to our confidence in the outlook. First, we expect to continue to grow our MRO and aftermarket bookings. As countries emerge from COVID, we are seeing higher utilization rates in our customers' facilities, which necessitates increased parts, replacement units, and service activity. Additionally, our distribution partners are just now beginning to replenish their inventory levels. After about six quarters of de-stocking, we are now expecting these distributors to rebuild their inventory levels over the coming quarters. Second, we believe major project activity will emerge and begin to recover in the back half of 2021 and into 2022. In the early part of last year, we had very good visibility to a significant amount of project activity that was expected to be awarded during that year. Most of those projects were put on hold as operators were assessing the COVID impact and reducing their capital spending budgets. Today, we're working with many of those same customers to bring those projects forward, as the economic environment has improved dramatically over the past several months. And additionally, our activity with EPCs has increased significantly this year. Finally, with the energy transition theme as a significant opportunity for Flowserve, to date, actual spending in this area is still very fast. But we expect it to grow substantially in the quarters and years ahead based on the commitments that our customers are making as well as from the potential for increased regulation in costs associated with emissions. Flowserve is no stranger to this type of work. And I'll talk further about this growing market later in the call. Even as the outlook and trends look promising, predicting the exact timing associated with these opportunities is still challenging. The Delta variant is causing concerns for Flowserve's operations and for our customers. We have remained diligent and focused on our safety protocols, and we have successfully limited pandemic impacts at most of our global facilities during the quarter. The recent upturn in COVID cases in the Americas due to the Delta variant has the potential to impact our return to office. However, we do not believe that the latest COVID trends will negatively impact our business and growth outlook at this time. Unfortunately, we did experience significant disruption in our Indian operations during the quarter. As a reminder, we have three large manufacturing facilities in several smaller locations in India. The good news is that we have seen tremendous improvements over the past several weeks, and we are currently operating at about 80% associate participation in these facilities, which is up from 20% to 30% participation that we experienced for most of the second quarter. Our Indian-based suppliers were also challenged in the quarter, which presented modest headwinds for us, but our supply chain team has done a good job mitigating the impact and leveraging our global suppliers to minimize disruptions. Let me now turn to our second quarter bookings. We're pleased with the 17.9% year-over-year increase, which brought this quarter's total bookings to $953 million. Both original equipment and aftermarket bookings grew in the 17% to 19% range. We're very pleased to have delivered almost $525 million of aftermarket awards this quarter, returning to pre-pandemic bookings levels for this part of our business. Each of our core markets delivered year-over-year growth, with the biggest drivers being oil and gas and chemical, which increased 39% and 19%, respectively. On a regional basis, we saw solid growth across the globe with the exception of the Asia Pacific market, which was negatively impacted by India's COVID resurgence and a more difficult compare period. Our bookings performance this quarter was driven almost exclusively by our aftermarket in MRO business, which represented a large volume of small awards. In fact, we only secured one award that exceeded $10 million, where FPD booked a $12 million nuclear power order in North America. To achieve this level of bookings without any large projects in the mix is an encouraging sign for future growth. We expect larger project spending to lag aftermarket in MRO work, and it has, and we are now confident in the return of project investment later this year and into early 2022 across our end markets. Our project funnel continues to grow and is up nearly 25% compared to this time last year, driven by the feedback we obtained from customer discussions, insights gained from EPC bidding and backlogs, and our interaction on the delayed projects, which were originally expected to be released in 2020. We continue to anticipate bookings in the $950 million range in this year's third and fourth quarters, assuming continued progress with COVID. At this level, we should see significant bookings growth in the next two quarters relative to the 2020 comparative periods. Delivering these levels of bookings or higher would position Flowserve well to deliver strong financial performance in 2022. Our results this quarter also help drive strong first-half results for 2021. Our adjusted decremental margins for the first six months were just 13% with our improved market outlook. We remain focused on returning Flowserve to growth while driving margin expansion and increased returns. I'll now turn the call over to Amy to cover our financial results in greater detail.

Thanks, Scott, and good morning everyone. Looking at Flowserve's second quarter financial results in greater detail, our reported EPS of $0.35 increased significantly over the prior year period. In addition, the quality of our earnings also improved with after-tax adjusted items declining from $61 million in the prior year period to just $3 million this quarter. Our adjusted EPS of $0.37 excluded just $0.02 of net items, including realignment expenses, below-the-line FX charges, and a gain on the sale of a business. We were pleased with these results, particularly considering the impact of COVID-related headwinds of about $0.02, primarily from our Indian facilities as Scott discussed. Second quarter revenue of $898 million was down 2.9% or 7.1% on a constant currency basis. The decrease was primarily due to the 6.1% decline in original equipment sales, driven by FPD's 19% decrease, but partially offset by FCD's 12% increase. As a reminder, FPD entered 2021 with an OE backlog down roughly 25% versus the start of last year. Aftermarket sales were relatively resilient at three-tenths of a percent, but mixed in composition as FPD's 11% increase was mostly offset by FPD's 1% decline. Turning to margins, our second quarter adjusted gross margin decreased 70 basis points to 31.4%, primarily due to early sales decline and related under-absorption, including the previously mentioned COVID impacts, partially offset by a 2% mix shift towards higher margin aftermarket sales. Sequentially, adjusted gross margin increased 100 basis points on solid 53% incremental margin performance. On a reported basis, gross margin increased 180 basis points to 31%, primarily due to a $23 million decrease in realignment charges as we took significant cost actions in last year's second quarter. Second quarter adjusted SG&A increased $13.9 million to $209 million versus the prior year, due largely to foreign exchange movements as well as the return of certain temporary cost benefits realized in 2020, such as the absence of travel that had begun to return. Reported SG&A decreased $18.5 million versus the prior year, where realignment charges declined $27 million versus the prior year. Second quarter adjusted operating margins of 8.5% increased 40 basis points sequentially, but declined 280 basis points year-over-year, primarily due to increased under-absorption related to FPD's OE revenue decline. FCD's adjusted operating margin increased 10 basis points year-over-year to 13.3%, driven by revenue growth and tight SG&A cost control, which were partially offset by mix headwinds. Second quarter reported operating margin increased 330 basis points year-over-year to 8%, including the $57 million reduction of adjusted items. Our second quarter adjusted tax rate at 14% was driven by our income mix globally, and favorable resolutions of certain tax audits in the quarter. The full-year adjusted tax rate is expected to normalize in the low 20% range. Turning to cash and liquidity, our second quarter cash balance of $630 million decreased $29 million sequentially, as solid free cash flow of $14 million was more than offset by our return of $38 million to shareholders in dividends and share repurchases. Flowserve's quarter-end liquidity position remained strong at nearly $1.4 billion, including $739 million of capacity available under our undrawn senior credit facility. Turning to working capital, it was a $34 million use of cash in the second quarter, primarily due to accrued liabilities and timing of certain payments, partially offset by modest improvement in accounts receivable and inventory, including our contract assets and liabilities. The performance was much improved from last year's second quarter when the COVID-related impacts and seasonal inventory builds resulted in a use of cash $36 million higher than this course. Taking a look at primary working capital as a percent of sales, we saw a modest 20 basis point sequential decrease to 29.4%, driven primarily by accounts payable, as well as a four-day improvement in DSO versus the first quarter. Despite our backlog increase of $66 million, some progress delays due to COVID and the proactive purchasing of certain inventory items to mitigate potential supply chain issues, we were pleased that our inventory, including contract assets and liabilities, decreased a modest $4 million sequentially. Working capital remains a top priority for us, and we're confident that the foundation has been laid for further improvement in the second half of the year as demand-related sales volumes increase results in further reduction of inventory levels. We remain committed to delivering free cash flow conversion in excess of 100% of net income for the second consecutive year. Turning now to our outlook for the remainder of 2021, based on the combination of our strong first half bookings, driven mostly by shorter cycle aftermarket and MRO activity, Flowserve was pleased to increase our adjusted EPS guidance range for the full year to $1.45 to $1.65. In terms of cadence, we expect volumes to increase sequentially in the third quarter and to deliver our typical fourth-quarter seasonality. Our adjusted EPS target range continues to exclude expected realignment expenses of approximately $25 million, as well as below-the-line foreign currency effects and the impact of potential other discrete items which may occur during the year. Beyond adjusted EPS, we now expect less of a revenue decline versus 2020. Our guidance is now for 2021 revenues to be 2% to 4% down compared to last year versus the prior guidance of down 3% to 5%. In terms of other guidance metrics, our net interest expense remains unchanged at $55 million to $60 million. We modestly lowered our adjusted tax rate guidance to 21% to 23%. From a bookings standpoint, we now expect full-year 2021 bookings to increase in excess of 10% year-over-year versus our previous outlook of mid-single digit growth. Additionally, we believe a majority of this increase will come from our aftermarket and shorter cycle MRO original equipment products, where the associated revenue may be recognized in 2021. Our expected major cash usages in 2021 remain in line with prior guidance, including dividends and share repurchases of roughly $120 million, capital expenditures in the $70 million to $80 million range, and funding our modest remaining realignment programs. In conclusion, with our solid first-half operating performance and improved market outlook, we look forward to continuing the momentum through the second half of 2021 and expect to be well positioned to drive margin expansion and earnings growth in 2022. Let me now return the call to Scott.

Thanks, Amy. Let me close with an update on our energy transition strategy and our outlook for the remainder of the year. As I mentioned earlier, Flowserve is well positioned for energy transition. In fact, energy transition and de-carbonization activities have been a part of our offering for the last few decades where Flowserve has a demonstrated foundation and product portfolio to capitalize on this growing market. We estimate that even before the recent increased awareness driven by the global pandemic, Flowserve is delivering $100 million to $150 million annually of equipment and services into energy transition related work, including areas like energy efficiency enhancements, upgrades, retrofits, carbon and emissions reductions, solar power facilities, bio-friendly processes in lithium and hydrogen work. Equally important, we have been a valued partner to customers in industries that have among the highest opportunities available from energy transition, and we are absolutely committed to supporting them today and through their energy transition journey. With increased government regulation and potential costs on greenhouse gas emissions, the financial community's increased focus on ESG metrics, and individual company's public environmental commitments, it is clear to us that energy transition represents a substantial growth opportunity for Flowserve. The International Renewable Energy Agency estimates that nearly $60 trillion will be invested over the next decade, with almost half of that focused on energy efficiency. Energy efficiency is essentially a continuation of existing process industries, but conducting that business in a more environmentally friendly and efficient manner. Year-to-date, we've booked nearly $100 million of energy transition related business. We have held numerous discussions with our customers over the last year, which have confirmed our approach, validated our offering, and these discussions support our growth ambitions. Let me now highlight some of our recent success stories. We're supporting a large customer in the United States to convert a former petroleum refinery to a biodiesel facility. To make the transition, a number of Flowserve pumps required upgrades to support the new application conditions and improve the operator's production and energy efficiency. Our work on the project will save the plant over $800,000 in electricity annually, which is equivalent to over 9,000 tons of CO2. Leveraging Flowserve's expertise in flow control solutions, pumps, and valves, we successfully support our customers' shift to renewable fuel and their de-carbonization efforts. Another example comes from China. Earlier this year, Flowserve received a substantial order for over 150 cc dry vacuum pumps for their production of polybutylene succinate or PBS, which is a biodegradable plastic that naturally decomposes in water and carbon dioxide. With China's recent demand on several types of non-degradable single-use plastics, PBS and other biodegradable plastics will be preferred alternative materials due to their similar plastic attributes without the harmful impact on our environment. As I mentioned earlier, we estimate that roughly $30 trillion of energy transition-related investment over the next 10 years will be focused on energy efficiency. Our RedRaven IoT offering launched earlier this year instruments pumps, valves, and seal systems to provide the capability to assist our customers with a data-driven approach on how to improve their operations, increase asset uptime, and reduce the associated energy emissions. We continue to incorporate our RedRaven functionality across additional valves and pumps in the quarter, increasing the coverage of our portfolio where we can provide advanced analytics and predictive capabilities. Customer interest levels remain high, and we continue to average roughly one order every week. We believe RedRaven aligns well with our customers' objectives and expect to continue to grow this offering to a meaningful level in the future. A recent example of the value of our IoT solution comes from a longtime Flowserve customer who recently upgraded their monitoring solution to RedRaven. Shortly after the upgrade, we detected that a critical pump motor was overfeeding. We detected the temperature spike early, alerted the refinery, and deployed resources to support their operations. According to the operator's estimates, had the pump failed, they would have had to shut down the facility for over three weeks as they removed the damaged pump and installed the commissioned end replacement. This downtime would have cost the refinery upwards of $20 million. Red Raven is clearly adding value to Flowserve and to our customers. Let me now shift our focus to the remainder of the year. During the quarter, I was excited to resume a more normal travel schedule and visited a number of our U.S. and European facilities and many of our customers in these regions. During these business reviews, I came away highly encouraged by the operational progress we continue to make in our transformation journey. The business validated the improvement we're making in a number of key performance metrics. I'm confident we're on the right path to fully embed the transformation work and activities into our daily processes. The Flowserve 2.0 operating model is being driven throughout the enterprise, and we continue to expect the transformation to be fully embedded by the end of the year. With our operations and functions now taking ownership, we expect continuous improvement to remain post-2021. Our improved model is expected to deliver a more consistent margin profile and ongoing productivity improvements, which would position Flowserve well to leverage and capture the value of the improved market opportunities. The visits also confirm that we are strongly positioned to shift our focus to growth, optimization, and strategic initiatives, including inorganic opportunities. The success of our transformation and a consistent operating approach provides me confidence in our ability to integrate acquired businesses should we see the right assets and economics. Our operational and functional organizations have made significant progress throughout this journey, and we are now prepared to do more. In closing, we began our Flowserve 2.0 transformation journey in 2008. Even as the pandemic required mid-course adjustments, we're approaching the full institutionalization of the playbooks and processes of our ongoing operating model. We're increasingly well positioned to support our customers in capitalizing on the improved market environment and create long-term value for our shareholders and other stakeholders. Operator, this concludes our prepared remarks. We would now like to open the call to questions.

And your first question comes from the line of John Walsh with Credit Suisse.

Hi, good morning.

Hey, John.

Obviously, you sound very confident in the forward trajectory here, taking up the order expectations. It appears by our math that implies backlog trough last quarter. And is it fair to say you'll continue to build backlog as we go through the year and potentially exit in that $2 billion plus zip code?

Yeah, certainly, we've had two quarters now with book-to-bill over one. We expect to continue that. We might have a little bit of a different dynamic in the fourth quarter as our revenues typically come up. But we expect to have a higher backlog at the end of the year, certainly higher than what we ended last year at, and as you pointed out, right, it grew this year and this quarter, and we expect that to continue next quarter as well.

Okay, great. And then maybe just on some of the items you called out as it relates to the margin bridge. I know we all call it corporate and unallocated and it's not true corporate because it's kind of what spills out that you don't allocate to the businesses. But could you help us with a clearer walk on some of the items that impacted this quarter? I think you called out temporary costs. I'm not sure if I heard FX, just kind of a little more color around those items. Thank you.

Sure. John, you're absolutely right that as we think about that corporate allocation, it's really a component of SG&A in totality, and the piece that's not been allocated out to our platform. So, as we look at the bridge, particularly year-over-year, FX is certainly a factor, and it's actually the largest factor in the mix that between call it $6 million and $7 million of impact in the second quarter. And then the second piece, as you've indicated, is really some austerity measures that were put in place either by necessity or by design in the second quarter of last year. So travel was obviously halted. We started to see some of that activity come back, particularly in the second quarter of this year. Some of our discretionary incentive programs did what they were designed to do, which was to pay out significantly below target based on business results in 2020. That is coming back to more like targeted levels and in the appropriate relation to our business results as we move forward. So we're starting to see the return of some of those normal business activities.

Just to add there, John, obviously, we have different parts of the business in different parts of the cycle, right. The pumps have that lower, longer cycle business, and that's the part that we've got to get that through the trough of the downturn and moving up. We're seeing recovery in our seal business, our aftermarket business, and the valve business, which is shorter cycle. And so that's what you would expect. But that longer cycle is just taking a little bit longer to move through the pricing pressures that we saw at the end of the year, in the beginning of this year, and then that absorption piece as well.

Great, thank you. I'll pass the baton.

Your next question comes from the line of Deane Dray with RBC Capital Markets.

Thank you. Good morning, everyone.

Good morning, Deane.

Hey, Deane.

Hey, if we compare your conference call, your prepared remarks to a number of the other - just about all the other industrial companies, you stand out as not complaining loudly about price cost, which is admirable, because you're also - you just don't see a big margin hit and then you have to explain the margin shortfall. So historically, you've always been good about getting price. So could you talk a bit about the dynamics here in price costs from both sides of the equation? Scott, you did mention that there was some working capital build or maybe that was Amy, working capital build and preparation not a formal hedge, but some pre-buy, but it didn't skew your inventory numbers. So just take us through price costs, where does it stand today, first half, what are your assumptions for the second half? Thanks.

Sure. Yeah, we certainly didn't complain about it. But I will say it is a major impact, and it is impacting our business. And so as you know, and others that have listened to industrial calls, it is an incredibly dynamic landscape, and certainly Q2 was at a peak of the dynamics. And so what we saw in Q2 was continued inflation on the cost side. We saw that really across the globe. But for us, the highest inflation has been on motors, in electronics, and then logistics. And so that's the area that we're really working to mitigate those inflationary metrics. I'd say our supply chain team is doing a really, really nice job and doing the best we can to accommodate for those price increases with our suppliers. But net-net, it was a headwind for us in Q2. I would say it was not a substantial headwind, but it certainly was that we weren't on the favorable side of price cost in Q2. When it comes to pricing, we have announced at the beginning of Q3, a price increase that was pretty holistic across most, if not all, of our products in the portfolio. Now we really won't be seeing the benefit of that until Q4 and early 2022, but that will be the second price increase that we've done this year. And then from a disruption standpoint, the biggest area of disruptors to - one regionally was India, right, so India was really devastated in the second quarter. A lot of our suppliers went offline. We were able to mitigate that with backup suppliers in Europe and in China. And then the other disruption impact has been logistics and electronics. And so on the logistics side, we're seeing significant price increases. But we're also seeing significant delays in the ability to get logistics providers. So we are seeing some normalization of that here recently, but I think that will still be a headwind in Q3. And then on the electronic side, we are seeing substantial delays and just lack of capacity. And I think this is an area where we have purchased ahead. It's not a major dollar item for us. We've built inventory there, and we don't expect significant delays or disruption with our RedRaven portfolio, our control valves, or our electric actuators. So we feel like we've been able to mitigate the disruption side reasonably well. And while the cost side has been a challenge, I'd say we're at a slight negative on the cost price, but not something material.

And just to clarify what's included in that price cost? Do you include the logistics, freight and then what about labor?

Yeah, I'd put logistics in there. We wouldn't consider labor when we talk price costs.

Alright, good, every company's got a different twist.

Yeah, that's a really good point. Let's say on the labor side - we feel reasonably good. There's a lot of talking, certainly today with the labor, the jobs number out there. But you're right now, we've done a lot of work on our culture, we've done a lot of work on making sure that we're paying at the right levels and our turnover, and we haven't seen a major increase there. And so there's areas of concerns. But overall, we feel pretty good with the levels of our workforce, our ability to attract talent, and it hasn't been a disruption for us thus far.

Alright, terrific. I especially like hearing that last piece on the labor side. And then the second question is the idea that the larger project funnel is beginning to come together. And we heard this very clearly from Emerson as well. And I know you track this, so just maybe share with us a bit of the precision that you have. It's more than just customer discussions. You mentioned the EPC bidding. So just what are all the indicators that you pull together that maybe formalizes this as a leading indicator for you?

Sure. At the beginning of - I'm trying to think of the year and it's all running together now for me, Deane, but at the beginning of the transformation, we launched a CRM project, it was one of our first enterprise-wide IT systems. As CRM is customer resource management, and essentially now we're putting all of our salesmen around the world are putting their forecasts into the system. So we have good visibility, we separate it by end markets and geography and customers. And that's a robust tool. And it's part of our DNA and our internal process today, and so now we've got good metrics that we can compare year-over-year, quarter-over-quarter, as we look at our project funnel and we look at our opportunities going forward. What we're seeing right now is a 25% increase in our forward funnel from what we saw last year at this time. What we've seen is every quarter that sequentially, that number continues to build and move up. If you complement that with our customer discussions, that I personally visited with many of our top customers in the second quarter, everybody's got a much more positive outlook in terms of their project spending, releasing projects into FID, and getting financed and funded. Just as they think through this, what's happening globally, we're getting more and more confidence on the ability to release those projects. I think the question still is timing. Will it happen? Do we see an uptick here at the end of the year? Or is it in 2022? I'm not - we're not prepared to make that call. But I do think you'd start to see more and more projects start to trickle in this year with a pretty significant increase here in 2022.

That's really helpful. Thank you.

And your next question comes from the line of Andy Kaplowitz with Citigroup.

Good morning guys?

Yeah. Hey, Andy.

Scott, I just wanted to follow up on that line of questioning in the sense that your gut for orders basically says relatively flattish in the second half of the year versus what you just did in Q2. You do say that you expect more project activity, but are you just kind of not putting in the guide more or less when you think about 950 million or so of orders each quarter? And then the aftermarket side, obviously very, very strong, has - is there a one-time sort of deferral component to it or do you think you can sort of rise from there?

Yeah, so alright, and you're getting granular on me and hold me accountable for this, I like that. So $950 million is kind of the run rate, and that obviously this quarter included significant aftermarket and MRO. We expect that to continue in Q3 and Q4. We do think there's a modest project build in the back half of the year. But if that happens in Q4, there's upside to a $950 number. So projects come back, we should be above it. If they're kind of at this level or slightly higher than we're essentially flat running at $950 into Q3 and Q4. Again, I'd say we're not exactly sure if it happens in Q4 or 2022. Not exactly sure, but we know that it's coming. So picking that precise time of when these projects occur is very difficult. But we feel confident that the projects are moving forward.

Very helpful, Scott, and then for a follow-up, maybe an assessment, you talked a little bit about Flowserve 2.0 in the prepared remarks, but how it's performing so far as we start, hopefully, this upcycle? I know, you said, and I don't want to say a few years ago, you want to record organic growth in the order of 2% above industry growth. It's hard to sort of measure that. But as we're starting to come out when you look at some of your longer-term programs such as strike zone or commercial intensity, how are they faring? And how did that contribute to, for instance, that aftermarket bookings number?

Sure. No, I think those programs have worked really well, and so commercial intensity is really focused on aftermarket and MRO, and to book a $500-plus number this quarter is fantastic. We're now at pre-pandemic levels for aftermarket and MRO business. I don't think we would be there without that commercial intensity program. The growth-focused strike zone, commercial intensity, and some of the other things that we've done on our product side are absolutely helping us return this business to growth. I feel really good that we've made that progress. It's institutionalized deep into our organization and that continues to drive bookings as we go forward. The other piece to that is the distribution channel hasn't come back as we really thought that it would happen at the beginning of this year. We haven't seen that, but in our discussions with distributors and some of the comments that are made publicly from those that do report public financials, I fully expect those distribution bookings to come back in the second half of the year. That not only helps our general industries category, but it helps that MRO work as well.

Appreciate it, Scott.

Your next question comes from the line of Nathan Jones with Stifel.

Good morning, everyone.

Good morning, Nathan.

I'd like to just have a discussion on the incremental margins or the decremental margins. I think it's probably instructive if we split those up saying as FPD is likely to have revenue declines and FCD is likely to have revenue increases in 2021. The FPD decremental in the second quarter was 40%, which I think in order to get to the full year decremental numbers you're likely to need to see that improve. I would think mix is one of the reasons that that should improve going forward. But if you could just talk about what the expectations are for decrementals for FPD in the second half and why they should improve.

Sure. And Nathan, I think you're looking at it the way that we are, which is taking 2020 versus 2021 as a full year versus quarter-by-quarter. Some of the cost actions that we took in the second quarter of last year resulted in a significantly lower cost structure, while we were still benefiting from a relatively healthy backlog. As we look at the second half of the year, you're absolutely correct that sequentially we are anticipating really strong incremental margins from the first half of the year to the second half of the year. That is benefiting from the mix that we're seeing in the bookings that we've recorded this year. But what is a headwind there is that those FPD original equipment sales volume is really not coming back until the last quarter of the year. That means that those facilities where it's really hard to get cost out, we are experiencing under-absorption at those pump facilities and that is impacting us. As we make our way sequentially through 2021, we think we're going to see better margins in the third quarter than we saw in the second quarter. But we're really going to see a strong uptick in consolidated margins in the fourth quarter as we get those volumes back to more historical levels from an FPD perspective, and we're benefiting from that mix shift that we're seeing in our bookings right now.

Thanks for that. One and then the incremental margin in FCD in the quarter was a bit lower than I would have expected at 13% Maybe that has something to do, again, with the cost actions, temporary cost actions taken in 2020. But just if you can talk about what drives the improvement in incremental margins in FCD in the back half of the year.

Yeah. So I think even within the FCD space, there still are margin or mix benefits that we're going to continue to get from that increased MRO bookings that we saw in the first half of the year. So although the mix looks good, we're going to continue to see that the sort of wind in our sails in the back half of the year.

Great, thanks for taking my questions.

Your next question comes from the line of Joe Giordano with Cowen.

Hey, good afternoon, guys.

Hey, Joe.

Hey, so directionally I hear EPS targets going up, you're raising your guidance on orders. So I think that those - the messaging there is pretty clear. But Scott, internally, you don't give quarterly guidance. So how do you kind of rate 2Q relative to what you thought three months ago? And has your confidence on delivering the full year, how does that compare to three months ago?

Yeah, Q2 is essentially where we had expected. And so there's always a little bit of puts and takes here and there, but overall, it largely came in how we were anticipating. As we think about the back half of the year, we've provided the EPS guidance range there. I just encourage you to think about that normal seasonality from Q3 to Q4. We feel very good that we can achieve the guidance range that we put out there. We're encouraged with the market activity, we're encouraged with the aftermarket bookings, and then we can fully expect our ability to execute is continuing to improve with the Flowserve 2.0 program.

And then my follow up is on - you made a comment on RedRaven and you stopped like a $20 million shutdown at a customer. How do you leverage an outcome like that whether it's until like being able to price this for value? Like, how do you make sure - that's a big - that's a lot of savings for a customer? So like, how are you adequately compensated for providing that sort of cover for them?

Yeah, that's a great question, Joe. It's one that we talk about a lot here at Flowserve. We've done a lot of work on the different contracting models with RedRaven. We've moved originally from selling some of our prototypes and installing that to now subscription and recurring revenue models. Ultimately, what we want to get to is some sort of performance metrics that we would put on the back of instrumenting and enabling IoT across the customer's infrastructure. I can just say that we are highly focused on extracting as much value as we can from this solution. It has been a little challenging as we've pioneered and pushed this thing out, but I say we're evolving more and more to performance-based contracts, which I think is absolutely the direction that we need to go. The other thing I want to add is we're continuing to see a great uptick with our customers in their adoption of our technology. I said this in the prepared remarks, but we continue to book about one new contract or one new installation every week. We've now instrumented over 5,000 assets with RedRaven. One of the things that we'll continue to track is how many assets are out there and how many we continue to move forward under our system and monitoring. The more data that we get from this, the better solution we can provide our customers. The example of the pump nearly failing with the overheating that I provided in the prepared remarks, that now becomes a case study. It's part of how we sell it, and we've got lots of examples like that that we're using. As we continue to show the value, we continue to talk about the different case studies we've used, I expect us to continue to deploy and grow this offering significantly in the years to come.

Perfect. Thanks, guys.

Your next question comes from the line of Josh Pokrzywinski with Morgan Stanley.

Good morning, guys.

Good morning, Josh.

Hey, Josh.

Just, I guess, a follow-up on Andy's question from earlier about kind of the order cadence maybe relative to some of the stuff you're seeing out there. Scott, I guess I hear you loud and clear on the big projects, I guess some more idea on the distributor restocking. What do you think that order of magnitude in terms of what that could look like just based on your guys' impression of sell-in versus sell-out, or where inventories versus normal can go and is that contemplated in the $950 run rate you guys have talked about?

Sure. We've embedded the distributor uptick in our numbers. It's kind of similar to what I said in projects. If we see a significant distribution restocking program, then there we've got some upside to our MRO and aftermarket numbers. I think we've had a lot of good discussions with our distributors. We looked at their public financials as well. Essentially, what you saw was very strong revenue and bookings growth for them in the second quarter with inventories flat to slightly down from where they were. The public companies that are out there have all talked about, they have to build inventory in the back half of the year. I don't expect them to go crazy and build significant inventory. But I do think we see an uptick for us primarily in our valve business and some of the pumps products as well. I think it's a modest uplift for us. I don't think it's something that's going to be significant in hundreds of millions of dollars, but it's certainly a step in the right direction. They're important channels of the market for us. We've got a large percentage of our revenue that does go through distribution. So any increase they have on their inventory levels is positive to Flowserve.

Got it and then just coming over to the ESG side and energy transition, I appreciate the color there. I guess if we take a step back, do you view that as sort of being decoupled from your customers' typical capital cycles? Or maybe even their own cash flows? Like, is more of this spending involuntary? Or do you see it's still having some measure of kind of correlation with the overall economic health?

I think what we're seeing specifically in the energy efficiency side, right, we're coming in, and we're talking about the efficiency of their pumps and their entire flow loop, those discussions - and when we get that work, and we've got a couple of those that are moving forward, right now, it appears that that's outside of their normal operational spending. It's something that they're thinking about, they want to do, they're making external commitments on CO2 reduction. What we're finding is we're coming in consulting and having incredibly rich and collaborative dialogue across our two organizations. When we identify the size of the prize, like the example we showed in the prepared remarks, when we see those savings numbers of nearly a million dollars a year on costs combined with the CO2, carbon intensity reduction, then it's really hard not to fund that. I think it's outside of their normal operating plan. We've got to sell at the right level, but again, it's a very consultative sell. We're involved heavily with looking at their data and working with their engineers. But when we define the size of that prize, it's really hard to ignore that. We're in several discussions that are ongoing, and I expect this part of our business to grow pretty substantially as we go forward.

One additional comment I would make there is, unlike other large spending cycles, this spending won't necessarily just be tied to GDP growth. Because to the extent that there are regulations that come into place, this spend may become part of what it costs to do business, versus something that you can do as revenues increase. I think that that is a distinction versus spending cycles we've seen in the past.

Excellent. Appreciate the detail there and best of luck in the second half.

Yeah, thank you.

Your next question comes from the line of Joe Ritchie with Goldman Sachs.

Thanks, good morning, everybody.

Hi, Joe.

Good morning, Joe.

I appreciate the color earlier and the challenges that you faced in India this past quarter. I was actually curious about China. I remember about a year ago, you guys had some supply chain disruption. Just given the Delta variant is proving to be more challenging today, I'm just curious, like, how are things in China right now, particularly from a supply chain perspective?

Sure. We're watching China very closely. I would say today, no major issues, but it's something that's on our radar screen. The good news there is we do have backup supply chain outside of that region. I don't see that having a material impact on our ability to execute and operate in the back half of the year.

Okay, that's good to hear Scott. I guess maybe just my follow-on question. I know you guys feel better about the potential order inflection. And talking about the funnel and how confident you feel about it. I guess if you look at your OE orders so far, the first half of the year, still pretty low relative to history. I know under-absorption has been an issue for margins. I'm just curious, like, is there anything you can continue to do to maybe right-size the fixed cost structure of the business such that the under-absorption is less of an issue, if in fact it takes longer for original equipment orders to come back?

Sure. It is an incredibly important part of what we're doing. I'd say there's really two main drivers here, but one is the absorption. We've got an ongoing program to take roofline out of our total infrastructure as it relates to Flowserve. We've completed two of those activities year-to-date, 2021, and we will continue to do that. Right now the OE volumes are we think at the absolute low, it only comes up from here, and so that was super important to do those exercises in 2019, '20, and year-to-date. The other important point here is as we continue our lean activities, as we continue to get more and more productive under the 2.0 transformation, we feel we still have opportunities to consolidate and reduce roofline. I really believe that we can continue to do kind of two to three facilities every year and continue to take out that fixed cost within the enterprise.

Okay, great. Thank you.

And your last question comes from the line of Andrew Obin with Bank of America.

I guess good morning. Thank you for putting me in.

Yeah. Hey, Andrew.

Hey, how are you? Just a question on free cash flow, your seasonal pattern I think has changed materially from what it used to be, right, consistently cash generative, early in the year. I was just wondering, as the industry - as volumes improve, is this something that will carry over as the industry normalizes? Or will you need sort of committed working capital which was the pattern to return to the past? Just maybe you can also talk about what kind of long-term changes you've made to your processes to enable better cash flow conversion throughout the year. Thank you.

Sure, we're pretty pleased with the progress that we've made related to working capital in 2021, particularly, because we think that we're doing it against a fairly challenging backdrop. As we look at when it's difficult to make working capital step changes, it's during times of increased bookings, during supply chain - times with supply chain disruptions. We've got all of those things going on right now, and we've still been able to see sequential improvements. I think that that's really a result of the processes that have been put in place as part of the transformation. So on that journey, we really started with what was happening in terms of cash collections, and driving down DSO, which we did again this quarter, sequentially and year-over-year. We really focused on putting processes in place to drive improvements in inventory levels. We see that with planning that's taking place between sales and our operations on a weekly cadence that allow for us to really focus on the inventory items that are hard to get and we need. Although we're taking some proactive steps to make sure that we have the items in stock that we need to meet demand, we're still able to drive that number down. As we make our way through 2021, I think that we're going to get some help from the denominator. As our sales volume increases in the third and fourth quarter, I think we're going to start to see those PWC as a percentage of sales come down closer to where we were in 2019 and ultimately make some movement into what is Scott and I's goal of getting to the mid-20s from a primary working capital standpoint. To come back to kind of the original tenant of your questions, we don't think that the movement that we've seen in the first half of this year needs to be an anomaly. It's the second year in a row that we've driven free cash flow in the first half of the year. I think as we look forward, we're going to continue to look for less seasonality rather than more in our free cash flow conversion.

That's great. Just a follow-up question. As we're sort of moving - once again as sort of seems like we're starting to see light at the end of the tunnel with the cycle, how is the quality of the bookings, right? Because at the bottom of the cycle, there is more competition for what's out there. People need to sort of cover their fixed costs. As the cycle recovers as well as the bookings, clearly, still not a lot of large projects, which tend to be more competitive, right, so the mix probably is good, but on the other hand, I think was a big shock to the system. How should we think about the quality of backlog whether pricing or terms? And how long do you think it takes for sort of things to normalize as business getting back to normal in terms of the bidding process? Thank you.

Yeah. Obviously, in the depths of the downturn in late 2020, there was a lot of just uncertainty and just a lot of our competitors taking price down significantly. In order to compete and continue to win work, we did have to follow the suit. That was the primarily or the biggest impact for Flowserve was in the pump OE business, the valves, and the seals, and our aftermarket, we’ve been able to keep our pricing relatively stable. Where we are today versus a year ago is we're in a much better position. There's still a challenge on the pump, OE pricing. I do think that gets better as projects start to move forward. As we start to see an uptick in those - that level of bookings and activity, I do think that we start to move into a positive place on the pricing side. While we're not where we want to be, it's substantially better than a year ago, and I think it'll be a lot better six months from now than it is even today.

No, thanks so much. Cash and bookings show how hard the team has worked. Thanks a lot.

We appreciate that. Thank you.

There are no further questions at this time. This concludes today's conference call. Thank you for participating, and you may now disconnect.