Flowserve Corp Q2 FY2023 Earnings Call

Good day, and welcome to the Q2 2023 Flowserve Corporation Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to hand the call over to Jay Roueche, Vice President of Investor Relations and Treasurer. Please go ahead.

Thank you, Ali, and good morning, everyone. We appreciate you joining our conference call today to discuss Flowserve's second quarter 2023 financial results. On the call with me today are Scott Rowe, Flowserve's President and Chief Executive Officer; and Amy Schwetz, our Senior Vice President and Chief Financial Officer. Following our prepared comments, we will open the call for your questions. And as a reminder, this event is being webcast and an audio replay will be available. Please note that our earnings materials do, and this call will, 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 2, 2023, and they involve risks and uncertainties, many of which are beyond the company's control. We encourage you to 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 that are accessible on our website in the Investor Resources section. With that, I would like to turn the call over to Scott Rowe, Flowserve's President and Chief Executive Officer for his prepared comments.

Great. Thank you, Jay and good morning, everyone. I couldn't be more pleased with the results that we delivered in the second quarter including our adjusted earnings per share of $0.52. We continue to build on the operating momentum established at the end of last year and I believe we are now delivering much closer to our true capabilities. I want to start by thanking our associates for their commitment to our customers and Flowserve. Without their persistence and dedication, we wouldn't be in such a good place. Our results for the second quarter were highlighted by the sixth consecutive quarter with bookings over $1 billion, our highest quarterly level of revenue since 2015 and our second consecutive quarter delivering adjusted gross margins above 30%. Our improved operational execution combined with our constructive market outlook has led us to raise our full-year revenue and adjusted EPS targets. During the second quarter, we generated bookings of over $1.1 billion. This performance drove our first half book-to-bill of 1.05 and our backlog to near-record levels, which reflects the success of our targeted 3D growth strategy and our customers' ongoing global focus on energy, security and decarbonization. 3D awards increased roughly 9% versus the prior year to $325 million. This amount included discrete energy transition and new energy awards exceeding $50 million, which represented an increase of 24%, compared to last year. Similar to the first quarter, we did not benefit from any large projects awarded in the second quarter. In fact, we only received one project over $20 million. This quarter's bookings were driven primarily by aftermarket MRO and small project work including numerous awards in the $5 million to $10 million range across all regions and end markets. Following our 10th consecutive quarter with a book-to-bill that exceeds 1.0, Flowserve's $2.8 billion backlog currently leaves us well positioned to deliver revenue growth through 2024. Second quarter revenue grew 22.5% and approached $1.1 billion, driven by a better operating environment and significantly improved delivery performance. The process and operational improvements that we have made over the past year are now showing up in our financial results. From a profitability standpoint, we again delivered adjusted gross margins exceeding 30%. Gross margins improved year-over-year due to better price-cost management, further manufacturing absorption and also from the avoidance of high frictional costs that we incurred throughout last year. We also expanded our year-over-year adjusted operating margins for the third consecutive quarter, due to our ability to execute on the backlog while remaining vigilant with our overall cost structure. With our improved operating performance and the constructive outlook in our markets, we are increasing our full-year adjusted EPS guidance to $1.85 to $2. Turning to our bookings in more detail. Our strong performance this quarter was primarily driven by record aftermarket bookings of over $590 million, representing a 12% increase over the prior year. Original equipment bookings also increased by a modest 0.4% year-over-year, driven primarily by MRO and small project work reflecting the previously mentioned absence of any large orders. We continue to expect the overall environment for original equipment to remain supportive as our project funnel over the next 12 months is up nearly 20% since the beginning of the year. Several years of underinvestment coupled with the relatively high utilization rates at our customers' facilities has served as the catalyst for the strength in our aftermarket and MRO business. This reasonably stable recurring and higher-margin type of work is further supported by operators looking to ensure the reliability and efficiency of their facilities with a primary focus on reducing the likelihood of any unplanned downtime. At this time, we see no signs of our MRO or aftermarket business slowing down. Each of our core end markets delivered solid year-over-year growth with the exception of chemical. In general industries bookings were up 20% and oil and gas was up 12%, while power and water were both up in the 2% to 3% range. Following 10 consecutive quarters of year-over-year constant currency bookings growth, our chemical bookings saw a year-over-year decline in the quarter of 11%, which was due to the challenging compare period as last year's second quarter bookings were near all-time high levels. From a regional perspective all of our reported regions were up year-over-year. We continue to expect that our end markets will remain constructive over the foreseeable future. Based on the current environment, we believe that we are likely in the early stages of a multi-year upcycle supported by the combination of energy security and energy transition, which aligns perfectly with our 3D strategy. We further expect aftermarket and MRO levels to remain elevated for the remainder of 2023 and into 2024. As mentioned previously our project funnel remains solid and represents significant opportunity for our traditional markets particularly in the Middle East as well as for decarbonization investment including increased nuclear activity LNG capacity additions and carbon capture opportunities. Let me now turn the call over to Amy to address our second quarter financial results in greater detail.

Thanks, Scott, and good morning everyone. Looking at our financial results in detail, we are pleased with our performance and the continued improvements in execution across both segments during the period. In the second quarter, we achieved $0.52 of adjusted EPS on revenue of nearly $1.1 billion, our highest sales since 2015. The strong results from the first six months of 2023, along with our operational momentum from recent quarters, give us confidence in our ability to execute on our sizable backlog, driving year-over-year revenue and earnings growth in the second half of the year and positioning us well for 2024. Reported earnings per share for the quarter was $0.39, mainly affected by realignment and foreign exchange charges. Costs related to the Velan acquisition and additional expenses from a previously reserved sales contract made up the remainder. Together, these expenses accounted for a total of $0.13 in adjusted items. Our second quarter revenue rose over 22% year-over-year, with contributions from nearly all areas. Original equipment and aftermarket revenues grew approximately 26% and 20%, respectively, compared to the previous year. At the segment level, FPD saw original equipment and aftermarket growth of 34% and 20%, respectively, while FCD posted original equipment and aftermarket growth in the 18% to 19% range. Regionally, revenues grew worldwide year-over-year, notably in the Middle East and Africa, and in Latin America where sales increased by 56% and 32%, respectively. North America and Europe experienced roughly 19% growth, while Asia Pacific contributed 7%. Regarding margins, we delivered solid year-over-year improvement this quarter. Adjusted gross margin grew by 190 basis points to 30.3%. This boost was driven by strong volume leverage from our operational execution, increased contributions from recent price hikes, and an improving supply chain situation. However, some of these positive trends were countered by the continued recognition of lower-margin backlog that was booked during challenging market conditions. Additionally, we are seeing the effects of higher compensation expense due to our annual merit increase and greater year-over-year performance-based expense accruals. Overall, we are pleased to have achieved over 30% gross margins in the first half of the year, which we believe we can maintain in the second half and grow from in the future. Moving forward, our initiatives aim to sustain a high level of gross margin performance, including improving the margin profile of incoming backlog, enhancing execution on the shop floor, and implementing our announced $50 million cost-out program, which entails an organizational redesign for improved accountability, speed, product focus, planning competencies, and our responsiveness to changes in business outlook. For the second quarter, reported gross margins improved by 160 basis points to 29.9%, although these improvements were partially offset by a $4 million rise in adjusted items primarily due to higher realignment charges from the prior year. Second quarter SG&A increased by $27 million to $219 million, mainly due to increased performance-based compensation accruals compared to last year and higher R&D investments to expand our 3D product offerings, though these were partially offset by a $4 million reduction in costs tied to a discrete legal matter. Adjusted SG&A as a percentage of sales decreased by 150 basis points to 20.2%, reflecting our success in leveraging higher revenue levels and realizing early benefits from our 2023 cost-out plan. This quarter’s SG&A percentage is the lowest we have recorded since 2015, except for occasional readings in the fourth quarter. As we grow revenues and maintain a focus on costs, we expect to stay in this range or better. Reported second quarter SG&A rose by $35 million to $230 million. This figure includes an $8 million increase in adjusted items, primarily due to a $7 million rise in realignment expenses compared to the previous year and $3 million related to the Velan transaction. Despite these year-over-year increases, reported SG&A as a percentage of sales fell by 80 basis points to 21.3%. Our adjusted operating margin for the second quarter rose by 320 basis points to 10.4%, reflecting strong operational performance, lower frictional costs, and ongoing SG&A control. FPD and FCD both delivered adjusted segment operating margins of 13.2% and 13.3%, respectively, showcasing year-over-year improvements of 380 and 80 basis points. The reported operating margin for the second quarter grew by 210 basis points year-over-year to 8.9%, where significant operating leverage was partially offset by a $13 million increase in adjusted items from the previous year. Our adjusted tax rate stood at 26% in the second quarter, much higher than our full-year guidance range, mainly due to the geographical mix of income and timing of certain foreign tax credits. Considering the second quarter rate, we expect our full-year adjusted tax rate to be around 20%. Turning to cash flow, we are satisfied with the first half operating cash flow of $50 million, especially since this period typically faces challenges. Thanks to our performance in the first six months of 2023, we've seen a $122 million year-over-year improvement, primarily driven by higher earnings and a $90 million reduction in working capital cash usage. We also improved from an inventory standpoint, with inventory including contract assets and liabilities for the first half representing a cash use of $78 million compared to $95 million last year. Even with the significant revenue increase, we saw a $16 million decrease in cash used for receivables, reflecting positive collection efforts, which improved our Days Sales Outstanding. We will continue to concentrate on enhancing our cash conversion cycle, which has faced necessary challenges in recent quarters due to our rapidly growing backlog and an improving, albeit still elevated, supply chain lead time. As a percentage of sales, working capital tied to recent bookings and backlog growth declined by 90 basis points sequentially to 31.9%. Our backlog has risen over 20% since the second quarter of 2022, but our inventory as a percentage of backlog has dropped by 130 basis points to 30.7%. We will continue to prioritize reducing our working capital investment below 30% of sales, driven by supply chain improvements and more consistent execution. In addition to working capital, substantial cash uses in the second quarter included $26 million in dividends, $17 million in capital expenditures, and a $10 million reduction in term loan debt. While we are pleased with the year-over-year improvement in free cash flow during the first half of 2023, we expect our traditional cash flow phasing this year to produce the bulk of our free cash flow, with a seasonally strong second half, particularly in the fourth quarter. Looking ahead to the remainder of the year, we anticipate continuing our healthy operating performance while capitalizing on supportive end-markets, delivering strong second half adjusted operating margins and adjusted earnings per share. We remain on track to achieve $50 million in full-year run rate cost savings by year-end through our organizational optimization strategy. Due to actions taken in the first half of the year, we've realized approximately $16 million in full-year run rate savings and are already experiencing benefits from the new organizational design, such as more efficient processes, better accountability, and increased focus on our products and services. With our near-record backlog of $2.8 billion in a constructive market environment, we now expect revenue growth in the 16% to 18% range, including a modest benefit from currency fluctuations, given the US dollar's weakening since the year's start. We've also raised our full-year adjusted EPS range to $1.85 to $2, reflecting our strong first half results and solid expectations for the second half. The midpoint of our range indicates a year-over-year increase in adjusted EPS of 75%. It is important to note that our guidance metrics for revenue and adjusted EPS do not account for any impact from the anticipated acquisition of Velan. Our adjusted targets also exclude identified realignment expenses of around $40 million, along with potential items that could arise throughout the year, such as below-the-line currency effects and implications from other discrete events like acquisitions or divestitures. With the identified realignment expenses and adjustments from the first half, we continue to expect our reported EPS to be within the range of $1.40 to $1.65. Both reported and adjusted EPS target ranges also depend on the stability of recent foreign currency rates, reasonable commodity prices, the absence of major geopolitical disruptions, and a supportive end-market environment. We anticipate a net interest expense of about $60 million and an adjusted full-year tax rate of around 20%. Finally, for the remainder of the year, considering our expected shipping cadence, we project our third-quarter adjusted earnings to align more closely with our first quarter results, but we expect to conclude the year with a robust, seasonally strong fourth quarter. Our updated range reflects the positive momentum we've achieved over the past three quarters and boosted confidence in our planning and execution.

Thanks, Amy. Let me finish our prepared remarks by discussing our 3D strategy, and our outlook for the remainder of the year. As our results indicate, the 3D strategy has been successful to date and embraced by our associates and our customers. Flowserve is well positioned to diversify into promising growth markets and digitize our installed base, while also supporting our traditional customers in their decarbonization commitments and new energy ventures. Looking at each of the pillars of the 3Ds and starting with our diversification efforts. Water is one of the markets we are targeting. During the second quarter, we received three water project awards totaling nearly $25 million. Another example of diversification is growing our vacuum technology into additional end markets. Recently, a global solutions provider for the food and feed markets selected SIHI's liquid ring vacuum technology to support the processing of edible oils and fats used in food and dairy alternatives. Flowserve's solution will reduce their operating costs, CO2 emissions and total energy usage. While this is only one illustration in the second quarter our vacuum pump bookings grew nearly 40% year-over-year as we continue to reposition the technology in new and attractive end markets. From a decarbonization perspective, our bookings remain strong including record energy transition bookings in the quarter as well as solid contribution from the nuclear markets where we booked two North American projects totaling $12 million. We remain very optimistic about the outlook for nuclear awards as countries increasingly focus on providing clean and reliable energy. Our current nuclear funnel is roughly double that amount it was at this time last year. Our strong nuclear portfolio of pumps, valves and seals supports facilities across the globe and Velan's offering will only further expand our nuclear valve capabilities. For decarbonization, I want to highlight our participation of planned expansion of a renewable products refinery. This project is expected to nearly double the facility's existing production capability for sustained aviation fuel and renewable diesel fuel utilizing Flowserve's valve and pump technology. Finally, on digitization, we continue to make progress deploying Red Raven our IoT offering and are now monitoring nearly 2,000 assets in over 70 customer facilities. Through the combination of new customers and renewals we are growing this offering's reach at nearly twice the rate of last year. We are committed to increasing the instrumentation of our installed base of pumps, valves and seals to support our customers' monitoring needs as well as providing predictive maintenance analytics and flow loop optimization. We believe that offering digitization capabilities will further position Flowserve to be a valued strategic partner by providing ongoing solutions to help minimize unplanned downtime and optimize their various flow loops. Flowserve was recently awarded contracts at three chemical facilities in Europe to monitor pumps, blowers, fans and mechanical seals with Red Raven's technology. I am confident that our technology will significantly improve the efficiency of these assets while allowing our customers to better monitor and plan their overall operations. During the second quarter, Flowserve released our 2022 ESG report. While this report provides great examples of our progress in each of these categories it also provides an accurate depiction of who we are and what we stand for at Flowserve. It truly captures the essence of our culture and our ambition to make a difference in the world through innovative flow control technology. We have categorized our ESG program within the context of three Cs: culture, climate and core responsibility. Additionally, our report highlights how our 3D growth strategy is in full alignment with our ESG objectives. I encourage everyone to review the full report and you can find it featured on our website at flowserve.com. Before I close, I want to provide a brief update on the Velan transaction. At this point, we have received all the necessary regulatory approvals with the exception of the French government. We are working diligently with the French authorities, but at this time, we do not have a clear view on their approval timeline. We do expect to have better visibility into a path for closing the transaction in the near future. We remain excited about the combination with Velan, and we are committed to working through the process to get to closing. Finally, I couldn't be more pleased with our progress this year, and I am encouraged by our results that we have achieved thus far in 2023. Despite our progress, there is more work to be done. We have further opportunities to drive margin expansion, continue to improve operations and ensure that we have the best possible portfolio for today's environment. This is only the beginning, and I am confident that Flowserve is positioned for additional success in the second half of this year and beyond. We are pleased to share that Flowserve will hold an Analyst Day in New York City in late September. At the event, we will provide an update on our markets, our 3D growth strategy, technology developments, long-range financial targets and our capital allocation framework. We will issue a press release in the coming weeks, with further details. In closing, I want to thank our associates for their efforts, which enabled us to deliver an outstanding second quarter. Together, we have made great progress on our operations in executing our 3D strategy. I remain confident in our ability to maintain our momentum and drive further improvements throughout the year. Our focus remains on converting our $2.8 billion backlog, pursuing accelerated growth through our 3D strategy, and driving higher margins and earnings by leveraging support of end markets, operational improvements and our new organizational design. I'm confident that executing this approach will deliver long-term value for all of Flowserve's stakeholders. Operator, this concludes our prepared remarks and we would now like to open the call to questions.

Of course, thank you. We will now take our first question from Nathan Jones with Stifel. Please go ahead.

Good morning, everyone.

Hi, Nathan.

Maybe starting off with one on the guide. 3Q looks a lot like 1Q, would imply that 4Q looks a lot like 4Q last year. I would have thought you had some tailwinds going on, in terms of better pricing coming out of the backlog maybe a better mix with all of these aftermarket bookings. Do you feel like there's still a degree of conservatism, which is understandable after the last couple of years baked into the guidance here?

Sure. Thanks for the question, Nathan. I'll start with this. I would say, overall, our philosophy on guidance this year has certainly been not to anticipate that everything goes exactly, perfectly as we make our way through the course of the year. And we certainly have a backlog in place that allows us to perform really strongly. As we think about second half incrementals, we think they're going to look a lot like the first half of the year, but that will be divided pretty heavily between the two quarters, with incrementals looking fantastic in the third quarter as we have a relatively easy compare, and then tightening in the fourth quarter of the year. Really the third quarter performance this year, as we sequence from the second quarter to the third quarter, has to do with some traditional things that we see between the second and the third quarter. I think the first is really around holidays in the Western Hemisphere. The second is around some revenue that we pulled forward and accelerated into the second quarter of this year. And the third is really around uncertainty of some of the timing of the actuarial liabilities that we threw up in the third quarter of this year. So, that kind of marks where we're seeing the third quarter in comparison to the second quarter.

And then maybe as my follow-up question, we'll talk about gross margins. It's good to see them getting back to this consistent 30% level. Again, you should have some tailwinds over the next 18 months as some of this backlog converts from better absorption, from better pricing coming out, probably some operational improvement that you've demonstrated here in the second quarter. Can you maybe talk a bit more about the medium-term outlook for gross margins and where you think they might be able to get to?

Yes. So, we definitely see that this year is sort of a stabilizing year from a gross margin perspective, with the opportunity to really grow beyond that 30% range. And you hit on some of the key factors, that I think we see as the short- to medium-term levers that we're pulling to both stabilize and grow margins starting with working off lower-margin projects that have been in the backlog for the past several quarters, getting to where we need to be from a price cost perspective and seeing those pricing increases actually flow through into our results. And then finally getting better operating leverage and absorption through the higher revenue levels that we've seen in the last several quarters. I think whether you want to call it medium to longer term, we still see that there are large levers for us to pull, and some of which we really put this new organizational structure in place to be able to pull on. And I'd start there with improved capabilities from a product management perspective and the ability and the willingness to rationalize our product offering. And then finally making roof line moves as permitted to really continue to make our way down the cost curve and grow those margins. And I think I just put in another plug for our Investor Day and say one of the things that we're excited about doing in September is offering more insight into our long-term targets and our levers to achieve them.

And then Nathan just to put it in perspective, we've said this before. We're very much focused on getting back to 2019 levels. And so that's our near-term focus. We want to get the gross margins at 32%, 33%. And as Amy laid out those short-term activities get us to that. And then there's still some levers beyond that with the product rationalization and the roof line that can drive us ahead. And so we feel confident in our ability to deliver the year with good margins and then we feel very good about the path to continuing to expand margins in 2024 and beyond.

Gross margin expansion and SG&A leverage ahead, I get it. Thanks for taking the questions. I’ll pass it on.

Yeah. Thanks Nathan.

We'll go ahead and take our next question from Joe Giordano with TD Cowen. Please go ahead.

Good morning guys. I have multi-part question on energy transition and then a quick one on Velan to follow-up. So I'll start, energy transition like bookings for the year, how big do you think that can be, and how big is nuclear? I don't think you combine nuclear into energy transition, right? So maybe if you could size both of those things?

The energy transition, which we also consider as new energy, reached $54 million this quarter, marking our highest achievement in that category. We are quite optimistic about this area, which includes initiatives like carbon capture and hydrogen. We believe we can sustain our growth here. Similarly, on the nuclear front, we recorded $50 million in bookings during Q2, which is a strong performance for us. Our outlook shows that our pipeline has doubled, giving us clear visibility for future projects. We have an impressive portfolio in nuclear that spans both pumps and valves, and we have strategic plans in place to boost our involvement not only in traditional power but also in small modular reactors and advanced nuclear projects. We see potential opportunities in Eastern Europe, Western Europe, and especially in Asia, with a focus on India. In the Americas, we are looking at life extensions. With our established presence in the nuclear sector, particularly concerning valves and pumps, any life extension for nuclear facilities brings us significant aftermarket business. We will elaborate more on this during Investor Day and as we progress, but we are very enthusiastic about the future in this area.

And then what is the company like Exxon potentially talking about becoming like a massive lithium monitor, I mean, for a company like yours? And then just a follow-up on Velan, is there something in France like I've heard that they maybe have a piece of business that's military or submarines that may have to be divested, and if that’s true, how large is that piece of business relative to the total?

Let me discuss lithium mining. Mining operations involve significant water usage, and we have pumps and valves designed to manage this water effectively. In the case of lithium, it is particularly water-intensive. We are optimistic about the demand for high-efficiency pumps in lithium mining, along with our valve solutions and mechanical seals. This represents a wealth of opportunities. As part of the energy transition, there is an increasing focus on batteries and rare earth minerals for energy storage, leading to substantial activity in this sector. Regarding Velan, as mentioned earlier, we are collaborating with regulators globally and have received approvals everywhere except in France. The process in France is challenging as it involves national security concerns rather than being anti-competitive. We are engaging with the Defense Ministry and the energy ministry, and we are committed to addressing their inquiries. We are hopeful that in the coming weeks, we will be able to provide more clarity on the timeline for closing.

Thanks, guys.

And our next question will come from Deane Dray with RBC Capital Markets. Please go ahead.

Thank you. Good morning, everyone.

Good morning.

Hey, Deane.

I may have missed this, but you mentioned there were no large projects during the quarter. Did you not have any to bid on, or were there just not many available? Could you provide some insight into your win rate?

Sure. We actually see a substantial amount of project work. And I would say with the backlog that we have and the margin expectations, we're being very selective on one what we bid on and then two what margins that we are prepared to win. And so we are looking at it at a balanced approach right? Typically these big projects are highly engineered work. They give us a lot of good aftermarket. We've got a better formula to make sure that we get the returns that we want. But again given the MRO activity so strong and the absorption where we are in our plans we're not going to get overly aggressive on this work, but our funnel is substantial. We've got visibility to a lot of this. And I'm not saying we're walking away from it, but we're getting a lot smarter about what we want to win and how we create value with those awards. So I'm optimistic that we will see some larger awards throughout the year but we're not going to over-rotate here and take work that doesn't bring the calories that we believe we deserve for the effort that it takes to perform these big projects.

All right. I love hearing the selectivity angle. So that sounds good. And then on the other side on aftermarket being elevated some perspective would be helpful here. So is this a result of overall industry activity being higher, capacity utilization being higher, or are you winning more of your share, or is it a combination was there some deferred maintenance that now you're getting that opportunity? So some perspective there if you could?

Certainly, Deane. The aftermarket bookings are currently at record levels, with a 12% increase year-over-year. This growth is driven by several factors, including the underspending during the COVID year, which has led to a catch-up period that started in 2020 and continued into early 2022. Additionally, many of our assets are operating at high utilization rates, which means as they wear down components like pumps, valves, and seals, we are seeing an increase in demand for our services. We have also made significant efforts in our services and solutions business, which supports the aftermarket. This includes lifecycle agreement contracts and a focused initiative on reducing lead times for coding and parts delivery. Our win rate and entitlement have improved as we engage with this increased workload, allowing us to capture more market share. Furthermore, there is considerable global activity around compliance, with new regulations and standards for emissions creating aftermarket opportunities for us. We observe this across seals, valves, and pumps, and these regulatory changes are contributing to our aftermarket growth. Lastly, we closely monitor this work daily and weekly, and currently, we see no signs of a slowdown. We are confident in maintaining this level of activity for the foreseeable future.

All right. That's all good to hear. And just one quick follow-up is what you have not said today like some of your industrial peers you haven't pointed to some destocking going on either at the OE or at the distributor level. Are you seeing any of that? Obviously, it's not showing up in your numbers. You're not – it's not in the commentary but any color there would be helpful.

Sure. Yes. I think the distributors – it's always a little bit of a game there, right? And it all depends on our lead times. And so when our lead times are short they can keep less on their shelves. When our lead times are long they've got to stock up and have the inventory for their customers. And so there's a bit of a balance there. Lead times globally are coming down, which is going to allow distributors to destock a bit. At the same time, our distribution bookings have been incredibly healthy last year and into the beginning of this year. And I really don't see that as a massive headwind for us. I think there – it might be flat for a little bit but the overall activity through our distribution channel has been really good. And so – and then you look at our general industry bookings, they're up substantial year-over-year. A lot of that was driven by some kind of unique project work that we picked up but overall distribution is hanging in there and I wouldn't see that as a substantial headwind as we go forward.

All right. I like hearing that in. Amy, thank you for all of the working capital and cash cycle updates and data points. Really appreciated that. Thank you.

Our next question will come from Andrew Obin with Bank of America. Please go ahead.

Hey, it's Sabrina Abrams on for Andrew Obin.

Okay. Hi, Sabrina.

Hey, could you guys give some color on the profitability for the decarbonization and clean energy projects? Would these have the same profile as maybe traditional EPC contracts or because their tax credits involved, does it sort of come in at a better margin?

No. Right now that work is pretty much on par with the rest of our portfolio. And I would say more in kind of that general industrial type work rather than the highly engineered oil and gas work. And so we like the margins there. What I will say is some of the projects attract a lot of attention, as you could expect and folks want to tell a good story there. And so sometimes we're seeing a little bit more pressure on price, but I'd say a good bar for that would be at least at the margins that you're seeing for SCD and FPD, sometimes a bit higher. And then if it's a flagship project it might be a little bit lower just because there's more people attracted to the project. What I will say is what we're very, very focused on is trying to select a handful of operators that are leading in the energy transition. And by doing that we can work with them more upfront and select Flowserve at the very beginning. And what we're finding when we're doing that is we get slightly higher margins. But more importantly, we're locked in through the design and the development and we've got a front-row seat to whatever that capability or that process is. So whether it's carbon capture or hydrogen or recyclables we're in the middle of understanding what the flow loop requirements are. And so that approach is working well. We feel like we're winning more of our share in the decarbonization. And I would expect, as we continue to learn more we'll be able to get higher margins both in the original equipment and in the aftermarket.

And I'd just add to that. I think the goal behind these projects is to make them scalable and repeatable. And that works for us as well as we're able to continue to repeat that design and get better and better at the manufacturing process it goes along. That helps us with margins over time.

Great. Thank you for that. And then I think last quarter and throughout like the past several quarters you've commented on seeing margins in the backlog improve and then cap getting better. Is this still on an upward trend, where the products you're currently booking, have a better profile than what's currently in the P&L?

That's what we see happening. And it's happening in two ways. One just the release of some of these lower-margin projects from the backlog over time and that's happening pretty ratably over the course of 2023. And the other thing that's happening in addition to just the overall environment being more constructive is the mix that we're talking about as we look at aftermarket and original equipment being one that's favorable overall to the margins in our backlog as well. So, we do view that as something that sets us up well, both coming into the back half of the year, but more importantly as we transition into 2024.

Thank you. I'll pass it on.

Next question will come from Michael Halloran with Baird. Please go ahead.

Hey, morning, everyone. So can you just talk a little bit more about the project funnel and how you see it laying out? Obviously, the commentary on the nuclear side and the confidence or the growing confidence you see in the energy transition piece that makes a lot of sense. So if you look at some of the more traditional pieces of your business, can you just talk to how you think that project funnel is developing in the marketplace? And if you think things are still being added or if there's any hesitancy growing anywhere in that chain?

The project funnel has shown positive growth year-to-date, surpassing last year's levels. Last year's funnel included the Jafurah project valued over $200 million. We're pleased with what the project funnel indicates. In terms of substantial growth areas, nuclear and LNG are both significantly up, along with decarbonization and new energy sectors. Regionally, the Middle East has the most opportunities, particularly in traditional downstream refinery and chemical businesses. In Asia, we have visibility on new projects, but they are competitive and more challenging to secure compared to opportunities in the Middle East or North America. Overall, there's a balanced mix of new and traditional projects, and I'm confident in our winning potential. As the market evolves, I believe pricing dynamics will improve, allowing for more victories on the OE side. Currently, we are in a strong position, with a backlog that permits us to be selective and disciplined, and I expect continued OE growth into next year and beyond.

Thanks for that. And a follow-up to part of the end of the question there which is just the pricing piece. Obviously, you feel comfortable about how you guys are managing your pricing I think we can see it in your backlog commentary. When you think about the end market dynamics or the marketplace dynamics, you mentioned you hope pricing can get a little better as we progress here. Are you seeing that happen anywhere at this point, or is this literally just you are being selective in the pricing, or are we getting to the point where there's enough capacity utilization from an industry perspective that you're seeing a little bit of softening in some of that competitiveness?

Yeah. We have seen a substantial improvement year-over-year in pricing. I'd say the whole industry is behaving and performing better. We would still like to see more improvement as we go forward. And there are still pockets that are highly selective. And so if there's a flagship project out there that might have the energy transition associated with it or something in the Middle East that could provide lots of aftermarket, we're still seeing some pricing that wouldn't make sense given where we are in the cycle. But I would say overall, it's substantially better than last year and I would expect it to improve from this point forward.

Thanks, guys. Appreciate it.

The next question will come from Damian Karas with UBS. Please go ahead.

Hey, good morning, everyone.

Good morning.

You sound extremely confident in next year. So maybe just playing devil's advocate a bit thinking about some of the macro trends things like PMIs and maybe territory. What would it take to disrupt that growth through 2024? Maybe if you could just kind of talk about some of the key risks? And are you thinking that bookings kind of flatline from here and you're getting that continued sales expansion for your backlog and projects, or are you kind of expecting you can continue to grow bookings into next year?

I believe that for 2024, we anticipate a modest increase in bookings based on our current project outlook and the aftermarket and MRO activities. While we shouldn't expect the same 15-plus percent growth we experienced last year, I do foresee modest growth ahead. The activity is present, and we have been selective in pursuing larger projects, but there’s no need to go after additional work considering our backlog. I am optimistic about the OE side and don't anticipate a decline in MRO and aftermarket, especially given the utilization rates and the recent regulatory compliance changes. However, potential challenges include any significant recession or economic outlook changes, which could affect our business. That said, I don't foresee such challenges based on the ongoing underinvestment in our end markets over the past few years, which suggests there will be growth opportunities for us in the coming years. This is evident in the positive sentiments expressed by oil and gas companies regarding their spending. Two significant factors driving this growth are energy security, as countries are keen to ensure stable energy sources, and de-carbonization efforts. I expect continued investment in both areas. When it comes to revenue for 2024, given our current backlog and bookings, we feel well-positioned. Bookings would need to drop significantly for us not to achieve revenue growth next year. We believe that we can grow the company in various environments as we move into 2024. Regarding margins, we are positioned to drive gross margin expansion in both the short and long terms. We feel confident in our ability to enhance bookings growth, revenue growth, and margin performance as we approach 2024.

I would just like to point out that at the beginning of the year, our backlog was smaller than it is now. Initially, we projected a revenue growth of 6% to 8%, and some people suggested that this indicated a negative trend in our business model for growth in 2023. The current backlog provides us with valuable insights into what we can expect for 2024, regardless of the macroeconomic conditions at that time, and it’s our responsibility to take advantage of that.

Great. Really appreciate all that. And times are pretty rosy right now, so just curious how you're thinking about managing the business, things like your staffing and headcount investment levels. And I guess just more generally costs in your footprint kind of just making sure that you don't get caught with your pants down the road when the tide does eventually turn.

Sure. We've announced a $50 million cost-out program, as we said in the prepared remarks that we're still on track to deliver that. And that is kind of the recession-proofing. And so there's opportunities to align our cost structure with some of the things that we think. And then, we've done the significant reorganization that we launched at the beginning of this year. And the new reorganization is really intended to focus more at the product level and the business unit level and support our 3D strategy. And so part of the realignment here is to really get the organization fully align with the 3D strategy. But then on the positive side, it helps us not only on the margins but it helps to think about and being preserved for the future there. So that's in place. We're committed to that moving forward. In fact, a lot of that work has already been done.

Great. Looking forward to the Investor Day. Best of luck.

Great. Thank you.

Our next question will come from Brett Linzey with Mizuho. Please go ahead.

Hey. Good morning, all. I wanted to come back to the project funnel. So just suggesting it's heavier aftermarket versus OE. I guess first is that the case? And then what is the typical lag between something that enters the funnel to an order to a shipment, and then just to follow-up off that.

Yes. Just to be clear, when we talk about the project funnel, that really is the OE work. It doesn't necessarily include any of our aftermarket business. And so the optimism there was really on the OE side and the project side. And we've got kind of a threshold that there's only projects that are a certain dollar amount in there or higher. And so this is really a nice barometer or an index for the larger EPC-type work that we see out there. And so again, we feel good about that. That funnel is up year-on-year without the Jafurah project, and we've seen a substantial increase since the beginning of the year.

And when we talk about the funnel, we are seeing about a subset of the funnel, which we believe will book within the next 12 months.

Yes. Thank you, Amy.

Yes. Got it. Thanks, makes sense. And then just back to the organizational redesign. I was hoping you could spend a little more time around the streamlining the efficiency efforts and is there a way to frame in dollar terms or margin terms what the enablement will be over time here?

Sure. We will discuss the enablement and its implications at the Analyst Day, where we’ll address our long-term targets and the impact of the reorganization. The reorganization has created two main divisions. Previously, we had three leaders, one overseeing the aftermarket business, but now we have seven business units with their own leaders. For example, we have distinct units for industrial pumps, our seal business, and engineered isolation valves, each led by a dedicated team. During Flowserve 2.0, we maintained a complex corporate structure that focused on defining processes and standards, but now we can streamline those corporate functions. This new structure emphasizes accountability at the seven business units. We are enthusiastic about this change, as it fosters a more customer-focused organization and simplifies operations across Flowserve. It enhances accountability for our outcomes and will contribute to the cost reductions we previously mentioned.

All right. Thanks for the insight. Best of luck. Great quarter.

Thank you.

Thanks.

And with that, that was our last question. That does conclude our question-and-answer session. I would now like to thank you for joining today's call. That does conclude today's call. Thank you for your participation. You may now disconnect.