Flowserve Corp Q3 FY2024 Earnings Call

Ladies and gentlemen, good day, and welcome to the Q3 2024 Flowserve Corporation Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Brian Ezzell, Vice President, Investor Relations, Treasurer and Corporate Finance. Please go ahead, sir.

Thank you, Lisa, and good morning, everyone. Welcome to Flowserve's third quarter 2024 business update. I'm joined this morning by Scott Rowe, Flowserve's President and Chief Executive Officer; and Amy Schwetz, our Chief Financial Officer. Today, Scott and Amy will provide an update on our overall business performance and highlights from the quarter. Following their comments, we'll open the call for questions. As a reminder, our discussion will contain forward-looking statements that are based upon information available as of today. Actual results may differ due to risks and uncertainties and these are discussed in our SEC filings, which can be found on our website. Our comments today also include non-GAAP financial measures. Additional details and reconciliations to the most directly comparable GAAP financial measures can be found in our third quarter press release and today's earnings presentation, both of which are on our website. And with that, I'll turn it over to Scott.

Thanks, Brian, and good morning, everyone. I want to start by saying thanks to Jay Roush for over 12 years of service at Flowserve, including two different opportunities to be our interim CFO. Jay did nearly 50 Flowserve earnings calls and was our conduit to the investor and banking communities. Jay, thank you for everything that you have done for Flowserve and making it a better company, and I wish you and your family the very best in the next chapter of your life. I'd also like to welcome Brian Ezzell to Flowserve. Brian will lead Investor Relations, Treasury, and FP&A. Brian brings significant experience and a wealth of knowledge to our team, and there will be several opportunities in the coming weeks for many of you to meet Brian in person. Let me now turn to our prepared remarks. We delivered another strong result in the third quarter, underscoring the positive momentum with our operations and end markets. I want to thank our associates around the world for their dedication to our customers and our company. They are truly what makes Flowserve an outstanding enterprise. I also want to welcome the associates of MOGAS to our Flowserve family as we kick off an exciting journey together. We are pleased with the results in the quarter and we believe there are substantial opportunities ahead to further improve our operational and financial performance to continue to deliver progress toward our 2027 financial targets. With bookings of $1.2 billion, our book-to-bill ratio in the quarter was over 1.06 times. We grew our backlog by $100 million sequentially ending the quarter at $2.8 billion and laying the foundation for continued growth into 2025. We delivered 240 basis points of year-over-year adjusted operating margin expansion resulting in an 81% incremental margin in the quarter. Our successful efforts with our customers generated both healthy project awards and strong aftermarket bookings of $615 million. We delivered nearly 30% growth in power bookings year-over-year, which brings the year-to-date bookings growth to 23%. We are optimistic about the power markets and Flowserve is well-positioned to take advantage of the global increase in electrical demand. I'll discuss this in more detail shortly. We generated sales of $1.1 billion, representing solid year-over-year top-line growth of 3.5%. Our third quarter adjusted EPS of $0.62 was a $0.12 or 24% increase versus prior year. Lastly, cash from operations of $178 million was particularly healthy, driven by working capital efficiency and earnings improvements. While our operating performance was certainly strong in the third quarter and earnings per share were higher year-over-year, both our reported and adjusted earnings per share were tempered by a discrete $0.07 charge in the quarter, which Amy will describe in more detail. All said, our second and third quarter results were operationally consistent and in line with the commentary we provided during last quarter's earnings call, with healthy project and aftermarket bookings, strong revenue conversion, and expanded margins. Our improved results throughout 2024 reflect initial progress from the new Flowserve business system. The business system helps to define how we operate consistently across our two divisions and seven business units. We are seeing early results from the operational excellence program, which is improving our delivery consistency, shortening lead times, and enhancing our product margins. Earlier this year, we formally launched our portfolio excellence program with the goal of optimizing Flowserve's 200-year legacy of brands and product families. Using a data-driven approach, we are undertaking a comprehensive portfolio review across three dimensions: products, customers, and profitability. Our ultimate goal is to reduce complexity in our overall offering, improve our customer service, and significantly expand our product margins without compromising our focus on growth. We remain committed to an incremental 100 basis points to 200 basis points of margin improvement from the Portfolio Excellence Program by 2027, and we expect to begin seeing results from this effort starting in 2025. We completed our acquisition of MOGAS Industries and are excited to officially begin the integration process. We believe this transaction positions Flowserve to further grow with their severe service ball valve offering that is complementary to FCD's expansive valve and automation portfolio. With annual revenues of roughly $200 million that are balanced relatively evenly between Mining and Process Industries and with EBITDA margins that are accretive to our FCD segment, we expect MOGAS will enhance our 3D strategy, be a strong addition for Flowserve, and support long-term value creation. Our thorough integration plan is intended to preserve and protect the legacy that MOGAS has created and build upon all the qualities that made MOGAS successful from its people and brands to its unwavering commitment to customers. Leveraging our combined size and scale, we intend to utilize Flowserve's commercial relationships and aftermarket capabilities to capitalize on future market opportunities. We are committed and have a clear path to $15 million of cost synergies by the end of year two and expect to have incremental revenue synergies by pulling through actuation, pumps, and mechanical seals on the back of MOGAS project work. Overall, our market outlook remains constructive for projects, MRO, and aftermarket activity across industries and end markets. We delivered bookings of $1.2 billion during the third quarter and have averaged more than $1.1 billion per quarter in 2024, resulting in strong year-over-year bookings growth. The ongoing success of our 3D growth strategy generated approximately 34% of our total bookings in the quarter, reaching the highest level in both absolute dollars and as a percentage of total bookings since we launched the strategy in 2022. These results confirm the merits and timing of the 3D approach with strong bookings obtained from both diversification and decarbonization activity. Our bookings were balanced in the third quarter with original equipment and aftermarket work each representing about half of the total. We secured six midsize original equipment awards ranging from roughly $15 million to $35 million. Combined, these project awards represent about $130 million of our total bookings, further demonstrating that our foundational core business of aftermarket MRO and short cycle activities is exceeding the $1 billion threshold on its own. This activity is driven by stable asset utilization rates at our customers' operations and our growing success in capturing the aftermarket on our substantial installed base. We delivered our second consecutive quarter of extremely strong aftermarket bookings at approximately $615 million. We have now delivered two consecutive quarters above the $600 million level, demonstrating the strength of our aftermarket franchise. Our customers have awarded their trust and this work to us due to our high levels of service, local presence, and healthy relationships. We believe that we can continue to grow our aftermarket business with improved service levels and further commitment to increasing our capture rate. Turning to oil and gas, our bookings were up 7% versus the prior period to almost $455 million driven by significant and broad-based activity throughout the Middle East region from Saudi Arabia to the UAE, and Qatar. We continue to see elevated levels of project activity in the region despite the ongoing conflict in other parts of the region. Let me take a minute to provide more detail on our power end markets, including traditional power and nuclear. As mentioned earlier, our power bookings were up nearly 30% to $155 million in the quarter and were up 23% year-to-date. We participate in virtually all forms of power generation, including traditional hydrocarbon forms like coal and combined cycle natural gas, as well as nuclear and newer energy technologies like concentrated solar power, wind, and hydrogen. As a result, we have significant power installed base across pumps, valves, and seals. Power bookings have historically comprised 10% to 15% of our total bookings in any given year, driven primarily by aftermarket MRO and some expansion activities. We believe we are at an important inflection point in the power markets with macro factors supporting projections for global power demand to grow significantly over the next decade. Power demand has largely been flat in Europe and North America for the last 15 years due to significant efficiency improvements. However, new power generation is now needed to support the growing demand for electricity and data centers to support AI as well as the electrification of nearly everything. These trends support the projections for power demand to grow steadily over the next decade. In particular, we see nuclear power growing substantially going forward due to its carbon-free emissions and baseload generating characteristics. In the quarter, nuclear activity saw particular strength with more than $100 million in bookings. We are currently seeing a combination of life extensions on existing assets in North America and Europe, combined with new nuclear capacity being built in Europe and in Asia. Life extension activities created substantial aftermarket opportunity for Flowserve to re-rate pumps and upgrade valves. Our project funnels for both total power and nuclear are up more than 20% versus this time last year, affirming the strong bookings we delivered in the third quarter and year-to-date. We believe this trend is in the early innings, and we are confident Flowserve will see growth over a long period as we build on our existing nuclear product and service expertise. We believe the overall macro environment and outlook remain favorable for Flowserve or the Flow Control space. We continue to see positive signals driven by key global megatrends, from energy transition and decarbonization to energy security and regionalization, and increasing strength in the power markets. Combined, these current and potential megatrends are attracting significant investments. Our traditional short cycle MRO and aftermarket business is proven resilient, and we are well-positioned to drive further growth from our large installed base. Through the first nine months of the year, our book-to-bill ratio is 1.03 times, and we continue to expect that our full year book-to-bill ratio in 2024 will exceed 1.0 times. Our backlog grew almost 4% sequentially to a near record level of $2.8 billion positioning us well for growth in 2025. I'll now turn the call over to Amy to address our third quarter results in greater detail.

Thanks, Scott, and good morning, everyone. Looking at our third quarter financial results in more detail, we generated revenue of $1.1 billion with an 11.1% adjusted operating margin, resulting in $0.62 of adjusted earnings per share, a 24% increase versus last year. We delivered another strong operational quarter and higher adjusted earnings, which were tempered by the discrete $12 million charge to operating income related to the annual actuarial assessment of certain undiscounted long-term liabilities. This third quarter expense impacted reported and adjusted earnings by $0.07 and reduced our operating margin by more than 100 basis points. We also had $0.18 of net adjusted items, bringing our reported earnings per share to $0.44. The two largest contributing categories of adjusted items were related to the realignment expenditures and acquisition expenses at $0.07 and $0.05 respectively. Given our results through the first nine months of the year, we are reaffirming our full year guidance metrics including adjusted earnings between $2.60 and $2.75 per share. This guidance includes the impact from the third quarter discrete charge for certain long-term liabilities and excludes the recently completed MOGAS acquisition. Our full year 2025 guidance, when instated in Q1, will include MOGAS. With year-to-date adjusted earnings of $1.93 per share, we recognize our full year guidance implies a wide range of outcomes for the fourth quarter. Based on our current outlook, we expect continued modest sequential improvement in our adjusted gross and operating margins, with our full year adjusted earnings per share likely closer to the midpoint of our stated range. Our more consistent quarterly performance this year is driven in part by the steps we have taken over the past several quarters to smooth the historic quarterly seasonality in our business and partially by the mix of our backlog. In the fourth quarter, for example, we expect less revenue from percentage of completion activities versus last year, which included significant sales and earnings from Phase 1 of the large Jafurah project. This softens some of our traditional seasonality and creates less variation in our results quarter-to-quarter from less of a ramp in Q4 revenue. Let me now turn to the quarter in greater detail. Both our FCD and FPD segments contributed to our 3.5% revenue increase, generating growth of 7% and 2%, respectively. By mix, we delivered year-over-year top-line growth of 5% in original equipment and 2% in aftermarket activities respectively. Almost all served regions increased sales year-over-year as well. We generated 11% growth in the Middle East and Africa region, as well as in Latin America. Europe contributed with a 6% increase compared to last year. Shifting to margins. We generated adjusted gross margins of 32.4%, representing a 270-basis point year-over-year increase and 10 basis points sequentially. The improvement was largely driven by solid execution and top-line leverage. We are particularly pleased with this margin expansion, given the higher revenue from original equipment work, which tends to have a lower margin profile than aftermarket. We expect these actions coupled with our operational and portfolio excellence efforts to deliver further gross margin expansion, as we progress towards our 2027 target levels. By segment, FPD's adjusted gross margin was 33.7%, representing a 410-basis point year-over-year increase. This robust segment performance is a result of improved execution, largely derived from the new operating model and divisional operational excellence initiatives. FCD delivered a 10-basis point year-over-year improvement with an adjusted gross margin at 29.9%. We believe FCD will deliver further sequential margin expansion in the fourth quarter due to improved revenue conversion, product mix, and cost-out activities. On a reported basis, third quarter consolidated gross margins increased by 250 basis points to 31.5% as improved operational execution more than offset the $2.3 million increase in net adjusted items within cost of sales. This quarter adjusted SG&A of $246 million increased $11 million year-over-year, which included the increased annual true-up of the previously mentioned actuarially determined long-term liability. Despite the dollar increase, adjusted SG&A as a percentage of sales was up only a modest 30 basis points year-over-year to 21.7%, reflecting the quarter's top-line growth and our ongoing cost discipline efforts. On a reported basis, third quarter SG&A was higher by about $7 million. As a percent of sales, reported SG&A was 22.9%, a 10 basis point improvement versus the comparable period. Our adjusted operating income in the quarter was $126 million, a $31 million increase year-over-year. Our strong adjusted operating margin of 11.1% was a 240 basis point expansion and represented an incremental margin over 80%. Absent the actuarially determined charge I referenced earlier, adjusted operating margins in the quarter would have exceeded 12%. On a year-to-date basis, we have delivered an 11.5% adjusted operating margin, representing a 230 basis point improvement versus the prior year. We continue to expect our full year adjusted operating margin to increase by at least 200 basis points compared to 2023 levels. This level of performance has Flowserve well on its way to achieving our 2027 adjusted operating margin target of 14% to 16%. By segment, FPD delivered a strong adjusted operating margin at 16.4%, which is a 410 basis point improvement over prior year. For two consecutive quarters, FPD has now generated adjusted operating margins of more than 16%, within the range of its 2027 adjusted operating margin target. Still, FPD has further opportunities to accelerate growth and expand its adjusted operating margin to the high end of the 16% to 18% targeted range. FCD's adjusted operating margin of 14% was lower by 70 basis points, but is a 60 basis point sequential improvement. We expect to generate continued adjusted operating margin expansion in FCD during the fourth quarter, primarily derived from the expected increase in gross margin. On a reported basis, third quarter consolidated operating margins increased 270 basis points year-over-year to 9.1%, driven by improved operating leverage. Our third quarter adjusted and reported tax rates were 19.7% and 22.8% respectively. This quarter's reported tax rate was higher than the adjusted rate, considering realignment activities and the below-the-line foreign exchange had unfavorable tax impacts on the rate. Turning now to cash flow. We generated record third quarter cash from operations of $178 million driven by strong earnings and substantial working capital improvements, particularly in accounts receivable. During the second quarter, our receivables were negatively impacted by the timing of revenues. As expected, this impact reversed during the third quarter, and we generated strong cash flow from our collections. Additionally, our cash conversion cycle declined by nine days year-over-year, driven by improved inventory turns and payables. As a percent of sales, our third quarter adjusted primary working capital improved year-over-year and sequentially by 260 basis points and 140 basis points respectively to 27.9%. With capital expenditures of $24 million, our third quarter free cash flow to adjusted net earnings was 189%. Historically, the fourth quarter has been our strongest cash generation quarter, and we expect a free cash flow to adjusted net earnings conversion rate at 85% or more for the full year. Altogether, we are pleased with the third quarter's operating cash flow results and our efforts to smooth the seasonality of our performance, which provide more opportunities to strategically deploy cash under our capital allocation framework. Other uses of cash during the quarter include a combined $46 million for dividends, a term loan reduction, and share repurchases. As Scott highlighted earlier, we successfully completed the acquisition of MOGAS Industries earlier this month. I want to thank all of our Flowserve and MOGAS associates who worked tirelessly on the transaction. Additionally, we appreciate the support of our banking partners, as we amended and restated Flowserve's credit agreement by extending its maturity to 2029 and increasing our term loan component to provide additional flexibility and liquidity. The MOGAS transaction checked all the boxes in our capital allocation criteria, portfolio diversification, aftermarket opportunities, strong financial returns, and straightforward integration, demonstrating our commitment to value-creating inorganic growth through a disciplined capital allocation approach. Our inorganic pipeline remains robust, and we expect to continue exploring acquisitions to further diversify our business and accelerate our 3D strategy. When considering the strategic use of capital, our framework will guide us in directing investment dollars to the highest long-term return option, including acquisitions, share buybacks, and pre-payable debt like our term loan. In closing, we are proud of the results we delivered this quarter and through the nine months of the year. We look forward to executing on the substantial opportunities ahead to further improve our financial performance. We are committed and focused on finishing the year strong and are confident that our continued progress will enable us to achieve our 2027 targets. Let me now return the call to Scott.

Great. Thank you, Amy. I want to provide a few comments on our 3D strategy. We delivered record bookings in the quarter from our 3D strategy, representing nearly $410 million. Our strategy is working in today's environment, and we fully expect continued growth in our 3D bookings looking forward. Our focus remains on supporting our existing customers in the energy-transition journey through decarbonization initiatives as well as adding value to new energy technologies like hydrogen and carbon capture. We intend to further diversify our portfolio into attractive markets like specialty chemicals and mining, as we did in the MOGAS transaction. Additionally, we continue to make progress with our digital offering Red Raven. We believe we have a differentiated technology and extensive domain expertise to monitor pump and valve performance, prevent unplanned downtime through predictive analytics, and ultimately help our customers optimize their flow loops. Let me highlight a few examples of our 3D strategy in action. Our focus on specialty chemicals is an example of our diversification efforts. During the quarter, we've received an order to supply vacuum pumps for a U.S.-based pharmaceutical company. To keep up with the growing demand, our equipment offers process efficiency to help to increase the supply of critical medication to patients across the country. In the decarbonization lane, we won a contract to supply pumps and valves for the construction of a new nuclear power station in the United Kingdom. The nuclear facility is expected to generate enough low-carbon electricity to power 6 million homes. We are excited to participate in this flagship project in the UK, which will provide reliable and clean energy to support their growing demands. Lastly, on digitize. Our ability to instrument our products with our Red Raven IoT offering positions Flowserve to provide true solutions for our customers and demonstrates the value of our digital capabilities. In the third quarter, we won a three-year contract to monitor dry vacuum pumps for a leading global soft drink company. With our 24x7 monitoring and predictive analytics, we expect to improve the uptime and productivity for this global customer. In conclusion, we delivered another strong operational quarter and are confident in our ability to build on these results. The macro backdrop remains positive, and we believe we can continue to drive growth in both our new and aftermarket businesses. We remain committed to our 3D growth strategy as it has proved successful over the past two years. Lastly, we believe we are currently ahead of pace on the journey towards our long-term financial goals. We have made great progress in the past two years, and we have a clear roadmap utilizing the Flowserve business system to deliver our growth and margin targets that we defined for you last year. Operator, this now concludes our prepared remarks, and we would now like to open the call for questions.

Thank you, sir. Our first question comes from Andy Kaplowitz with Citi.

Good morning, everyone. Scott, can you give us more color into what you're seeing in terms of bookings? At least one of your competitors, I think, talked about some slowing in process. I think there is some concern regarding slowed spending in the Middle East, both of which it doesn't seem like you're seeing. Do you see continued strength in the Middle East and overall process markets? And I know you reiterated Flowserve's bookings should exceed 1 time for the year, but do you still believe your markets overall are relatively early in their up cycle and book-to-bill could be over 1 time for the next several quarters?

Sure, Andy. Happy to talk about that. Let me start with aftermarket, then I'll go to projects. The aftermarket business is incredibly healthy. You were two quarters in a row now at $600 million. I'd say that the underlying health there is twofold. One, the process industries, the utilization rates, while maybe not at record levels are incredibly healthy. What we're seeing is the operators spending money to maintain those levels of operation. Turnarounds are back to kind of a more normalized level. We're getting parts pull through. We're getting service work. And then, the second part of this is, we've got a significant focus with the new org design on two of our business units, which are services and solutions for pumps and services and solutions for the FCD segment. That is all around capture rate and making sure that we get the value from our extensive installed base. And so, we're tracking essentially market share gains with improved capture rate on both the pump side and the valve side. And so, I'd say normalized levels of utilization with the process industries combined with our ability to drive capture rate up. We're confident that we can continue to see very healthy aftermarket work. In theory, we can continue to grow that business as we move forward. And then maybe moving to projects, right now, we see a very healthy pipeline for the foreseeable future. Your project activity has been robust this year, primarily oil and gas, Middle East has been one of the biggest drivers. Those awards made up a lot of the bookings, the project bookings in the third quarter. We still have visibility to very strong Middle Eastern work. And so, despite some of the hostilities in the region or in other parts, we're seeing Saudi Arabia, UAE, Qatar, Oman, Kuwait continuing to invest and progress forward. While a lot of our work is in the oil and gas side, it is the process industries like gas processing, LNG, refining expansion. We believe there's more work and substantial opportunities as that region continues to diversify. And so, we know there's a strong need for power generation next year. We've got very good visibility to that. We also know that the water demands in the Middle East continue to grow and so there's desalination opportunities. There's municipal water opportunities. And then the chemical side is continuing to expand as well. And so, I'm excited about the Middle East. We were there. We visit regularly. I was supposed to go last week, but went to Europe instead, but I'll be back in January. And at this time, we don't see any slowdown. And then, for rest of the world on projects, I'd say it's a little bit of a mixed bag. The U.S. and Europe project activity has slowed a little bit. With that said, we still continue to see very healthy activity in anything decarbonization, primarily around carbon capture, some of the biodiesel or bioconversion still happening, recyclable plastics are still a big thing in the decarbonization lane. And then, probably the next biggest bright spot is power. I talked about that in the prepared remarks, but our power overall funnel is up 20%. We've got very strong visibility to awards next year and the year beyond that. And then, we think nuclear is a very long-term play. These projects take a long, long time, but we booked over $100 million of nuclear work in the quarter and we expect to see continued growth from nuclear as we go forward. So, I'd say overall, look, the aftermarket business is healthy. We see growth opportunities there. And then, we've got several different levels on the project activity around the world. Today, we feel confident about our project outlook.

Very helpful, Scott. And then, Amy, maybe just in terms of the Q4 EPS, Scott, I think you're guiding to decently under 30% of the year's EPS in Q4. Historically, I think you're decently over 30%. As you said, is that just kind of deferral one leading to much higher front end? We know you're purposely intending to balance your quarterly earnings, but is there anything else that's a little bit lower or slower than you originally thought for Q4?

No. You've really hit on it. I think as we look at the fourth quarter this year, our ramp in revenue is a lot smaller than what we've traditionally experienced in the fourth quarter. Some of that is our efforts to improve conversion rates and the strength of the aftermarket business that Scott's referenced. In 2024, we just don't see that OE sales ramp that we saw in 2023 that largely came from Jafurah 1. In fact, Jafurah 1, our heaviest revenue quarters in 2024 were actually Q1 followed by Q2. I think we'll still see a bit of progression in margins particularly driven by FCD, where we should see a benefit from mix, as well as some of the cost-out activities that they're going through. Currently, FPD should be relatively in line with what we've seen. I will comment that any opportunity that we have to get to the higher end of the guidance range, which was somewhat mitigated by the size of the discrete charge that we saw in the third quarter would come from hitting the higher end of our revenue guidance range. Right now, I would suspect we'll be closer to the midpoint of that range, but if we see stronger book-to-ship revenue in the quarter or POC performance outpacing what we're currently scheduled to do from a production standpoint, that drives sales to the higher end of the range, I think that would be our path to the upper end.

And our next question comes from Nathan Jones with Stifel.

Good morning, everyone.

Good morning, Nathan.

I wanted to talk a little bit about a comment you made, Scott, in your opening remarks on data-driven approach to portfolio review with products, customers, margins, and the 100 basis points to 200 basis points target by 2027. It sounds a lot like an 80/20, quadrant-driven kind of model there. I'm interested to see where you think you are in the evolution of that process. Are we still segmenting the business in terms of those products, customers, margins? Are you to the deployment phase of that yet? And just any color you can give us on how that progresses over the next couple of years?

Yes, I'm happy to discuss the portfolio business system. Last year, during the Analyst Day, we provided some insights on product management and portfolio optimization. At the start of this year, we officially launched a comprehensive portfolio excellence program. This program follows an 80/20 framework and utilizes a robust data-driven approach to evaluate our products, customers, and profitability in making long-term strategic decisions about the best products for our customers and how to create value for Flowserve. We have three business units currently engaged in this initiative. One began in January, another in the second quarter, and the last one recently started. We anticipate that all five product business units will complete this process by 2025. We've already observed early positive results, which include implementing more systematic price increases and phasing out products that do not significantly contribute to the overall portfolio. Flowserve has a long history of diverse product families, leading to considerable complexity within our portfolio. I am optimistic about the benefits of reducing this complexity and focusing on the product families that generate real value for both Flowserve and our customers. We plan to officially launch this later in the quarter, and you can expect more updates from us. The early opportunities we've identified reinforce our previous statements from the Analyst Day, where we aimed for a 100 to 200 basis points improvement from product management and portfolio excellence. Given the preliminary outcomes, we are increasingly confident in achieving this as our target for 2027.

I don't want to get too far ahead of you on promising your targets, but Flowserve has over the years been a very complex organization with a lot of SKUs and different products in it, that maybe could be rationalized out of it. Other companies who've gone through this kind of process have delivered margin expansion that not only would be 100 basis points a year for the next few years, but on beyond that. It would seem Flowserve has probably a lot of raw material to work with there. Any commentary you can give us on kind of the duration past the targets that you put out there to date or potential for you to outperform those targets over the next few years?

Sure. I'll just start with kind of the history of this. We started something similar with Flowserve 2.0 and I just say the organization at the time wasn't mature, fully mature enough to do this. Now is absolutely the right time. The data integrity is better than ever. And so, really what I'm trying to say is, like we are in a position to truly capitalize on this today, given where we are with the business unit structure and the quality of the data or the improved quality of the data. We still have opportunities there. But, overall, it's far better than what it used to be. And so, to your point, what we've seen is other companies that have launched a very formal 80/20 framework, get substantial margin opportunity and expansion over kind of a let's call it a two to four-year period. And so, we're not going to change our 2027 targets of 100 basis points to 200 basis points. But I would say, if that was the end state for us, I would be incredibly disappointed.

Thank you. Good morning, everyone. And I'm sure he's listening, but I wish Jay all the best, and a welcome to Brian.

Thanks for that, Deane.

Sure. For Amy and I guess Scott too. I know you guys don't like to use the word asbestos, but let's just confirm that that $0.07 non-cash charge is related to this, what we know is a routine annual accrual true-up to your 30 year undiscounted asbestos liability. Again, I'll emphasize the routine part of it, but that's what we're talking about, right?

Yes. It's a process that we undertake every year in the third quarter of the year, based on claims experience for a number of years, including the current year and that's what the $0.07 is this period. You're correct that it is an undiscounted number. The duration of that liability is 30 years.

Good. I just want to ensure that was clear. Can we discuss free cash flow? I appreciate that you are significantly exceeding your typical third quarter conversion. Amy, could you explain the improvements observed in the cycle? When I notice structural changes like this, it leads me to believe that the 85% target conversion will eventually begin to rise, and I hope we can reach the 100% threshold at some point. Can you walk us through the structural changes that have occurred?

Sure. I think a couple of things. We were pleased actually to start the year relatively strong from a free cash flow conversion standpoint for Flowserve with positive free cash flow in the first quarter. The second quarter, the timing of our sales worked out in a way where we saw an accounts receivable build in the quarter, which is something that we've focused on pretty early with respect to our cash conversion efforts and we did see some of that reverse in the third quarter. In some ways, I see this performance in the third quarter being a little bit about a full year performance in terms of the timing of those cash flows or a year-to-date performance. But I think what we're incredibly pleased to see in the third quarter of this year in that nine-day cash conversion cycle improvement is improvement coming from inventory. And so, as we look at our operational excellence initiatives, that's obviously around margin expansion. Margin expansion does help cash conversion, but operational excellence also goes to how efficiently are we with our inventory processes. And so, we are starting to see that improvement in inventory and days sales in inventory, and that's something that we have to stay focused on, we have to stay mindful of and I do believe is a structural change in the business. And I'll quote Scott here, with respect to the margin expansion opportunities that we have, I'd be incredibly disappointed if we stopped at 85% free cash flow conversion. The goal is really to get to best-in-class with respect to those and the primary working capital performance we have as a percentage of sales that's something over time that we see is possible to drive more to the mid-20s, and even lower than that over time, as we expand margins and improve our working capital efficiency.

That's a great summary and provides a solid framework for us to monitor. As a follow-up for Scott, you are now in your 11th consecutive quarter with orders exceeding $1 billion. Please reflect on the significance of this streak for the organization, and reassure us that you are still maintaining selectivity in your approach. I want to ensure that the duration of this streak does not compromise the selectivity you have been practicing. Please elaborate on the importance of both the streak and selectivity.

Yes. I mean, I don't think we see this as a streak per se. I mean, what we're interested in is continuing to drive growth at Flowserve. We put out targets, long-term targets about a 5% growth rate from an organic perspective and that's what the organization is fully focused on. And so, when we think about the seven business units, each of those seven business units has a growth target and truly has growth initiatives that they're working on from either a product portfolio standpoint or customer account management standpoint or market share or parts capture rate, like all of those are deliberate actions. And so, I'd say what we're not waiting for is, we're not waiting to see what the market gives us. We're truly going out and being aggressive about making sure that we can win the work that we believe we're entitled to. Just the comment on the project side and selectivity, I will say, we are absolutely being selective. We are not backing away from that. We're seeing our ability to be selective and win the right work and when we're selective, we're winning work that one gives us the margins we believe that we deserve given the risk of some of those projects. But two, it's with customers that we know we're going to get the aftermarket entitlement over the long-term. And so, that's not going to change. We continue to be incredibly selective. We passed up on many projects, and some of our sales folks are absolutely thrilled about that, but it's the right thing to do for Flowserve and for our shareholders. And so, we'll continue that approach. I'd just say on the kind of the level of bookings, the aftermarket business is incredibly healthy at that $600 million run rate. We expect to see that to continue to kind of tick up as we go forward. Projects are always lumpy, but we've got good visibility and a healthy funnel there. I'd just say kind of that $1.1 billion level now is something that we aspire to be above on every quarter as we go forward.

Great to hear. Thank you.

Ladies and gentlemen, our next question comes from Mike Halloran with Baird.

Good morning, everyone. Regarding the power sector, it's encouraging to see that the secular trends are starting to take shape at Flowserve. How do you anticipate that evolving in terms of duration? We are beginning to notice some aftermarket activities, but refurbishment can be time-consuming, and projects may also take a while. Nevertheless, there's a lot of enthusiasm, and our order book looks promising alongside a strong sales funnel. Could you provide some insight into how this may unfold in the next two years?

Yes, I would say that the horizon is even longer than two years, Mike. This is a really slow-moving industry and certainly on the nuclear side. And so, we've seen nice growth year-to-date, up 23%. We like the bookings in the quarter, power is $150 million plus with $100 million of nuclear. The composition there was life extension in North America. We had two nice awards there, giving us a healthy mix of bookings. And then, also the spotlight award that I talked about on the new nuclear power in the UK. And then, I'd say just generally what we're seeing is, we're seeing traditional power discussions about how do we get power into, so, think about bigger refineries, process industries, desalination plants. There's a significant need for power to support those. And then, that's kind of that normal baseload and traditionally has always been the highest, now combined with this new need to power substantially large data centers. And so, you're seeing some pretty crazy stuff, where you get some of the big players in the tech space securing capacity with traditional power or even with nuclear power plants and we're seeing different dynamics in this industry than we've ever seen before. And so, I'd just say as we think through short-term and long-term, we've got a good healthy funnel around all power activity, both traditional and nuclear. But then over the longer-term, kind of the next 10 years, we really believe that nuclear will drive substantial growth. And I think you'll see more life extensions in North America. You'll see more kind of plants that have been taken offline getting moved to go online. All of those facilities in the U.S. have full serve content in it. In Europe, you're going to see plans for new build that's going to take place over the next 10 years to 15 years. India has got plans for new build and Asia Pacific has plans for new build. And so, this is, I'd say, just a very steady kind of a long-term growth outlook for Flowserve and for our kind of product families that support both traditional and the nuclear side.

Thanks for that. It makes a lot of sense there. And then obviously the recent acquisition really good fit. How are you thinking about the funnel from here of opportunities, the willingness for you to go after that funnel in light of the MOGAS acquisition, bandwidth, anything along those lines just to give some context for how aggressive the funnel looks and your willingness to go after it?

Sure. I think we continue to be active and grow our opportunity funnel from an inorganic standpoint. There's a lot of excitement around the MOGAS transaction and in part within our organization because it's such a great fit. And so, I just highlight the elements that we think make this work. One, it fits the strategy, helps us diversify. It is an attractive but fair purchase price with synergies available to us kind of at the $15 million run rate by the end of the second year. The last point that I'll make goes to your bandwidth, Mike, which is that it's a relatively straightforward integration for us. And so, we think as we finish out 2024 and move into 2025 that we do have bandwidth as an organization both from the strength of our balance sheet, which continues to get stronger by the day, but also within the organization to integrate acquisitions going forward.

Thank you. Our next question comes from Andrew Obin with Bank of America.

Good morning. Just a question on FCD and not to take away from the great progress over the past year plus, but just maybe you can give us more color on FCD, just margins, and also decline in OE bookings in the quarter year-to-date. What gets this to inflect positive and just maybe more color as to what's driving this decline? Thank you.

Sure. To begin with, we were pleased with the overall operational performance of the business in the third quarter. However, we had expected a bit more margin expansion in FCD during the quarter. The mix turned out to be less favorable than we anticipated, and the business decided to pursue additional cost-cutting measures. I'm not worried about the bookings we're experiencing, Andrew. We hope to see a shift in the mix toward the MRO aftermarket going forward to improve that marginality. Overall, as a business unit, we are committed to both growth and margin expansion, as Scott mentioned. Particularly within our four business units in FPD, we are focused on growth and margin improvement because we are happy with our progress, though not fully satisfied. As we assess FCD overall, we are looking for both margin expansion and growth. The bookings performance this quarter doesn't meet our expectations for the next three or four quarters, but if we can find ways to expand margins during this time, we will prioritize that over the book-to-bill ratio.

Yes. Just to add to that, the team's got several initiatives around how to expand margins. We're working on a couple of different things. And so, I think you can expect to see margin progression as we go forward even finishing the year, but also into 2025.

Excellent. And just a follow-up question on power. I know people are focused on nuclear, but we're also hearing that people are likely to keep coal plants open for longer. I was just wondering, what are you hearing from your customers about that? And what's the potential impact on earnings? I appreciate that nuclear is very profitable, but I would guess that coal is one of these legacy businesses that is profitable as well. Thank you.

Yes, absolutely. In the coal-fired power plants, we actually have a substantial installed base. And so, we benefit when there's a life extension of a coal-fired power plant. Typically, there's not really any new coal other than potentially some in China. But we are seeing extension of life on the coal side. We're seeing this in Europe as natural gas kind of dried up given the Ukraine conflict. We saw several operations in Germany and some other countries where they have extended the life of their coal assets. And then we're seeing a little bit of that in the U.S., and I would say that's probably more dependent on what happens in the election here. But I'd just say the overall comment, and this is probably more U.S. and Europe. Given the demand side of power right now, these markets are going to need all forms of electricity. And so, whether that's coming from traditional power, coal or combined cycle with natural gas, or nuclear or some of the greener forms of energy like solar and wind, everything is going to need to contribute to match the demand growth that we're seeing.

And our next question comes from Joe Giordano with TD Cowen. Please go ahead.

Thank you for answering my questions. I wanted to discuss nuclear energy. We've already spent some time on this, but with many developments happening in that sector regarding new capacity, whether it's small modular reactors or other innovations, how should we view your potential in these newer technologies compared to restarting older nuclear plants?

That's a great question. My comments were focused on traditional nuclear, which involves large power facilities that provide significant capacity to the grid. We're optimistic about the various consortiums, including the Department of Energy, working on the technologies needed for small modular reactors (SMRs). However, I want to emphasize that this development is not going to happen quickly. We are still in the early stages, and a lot of research and development is required to make SMRs a viable option. I would suggest that for the next decade, SMRs are unlikely to become a significant part of our portfolio. Beyond that timeframe, the future is uncertain. Some of the technology shows great promise, and certain projects in the U.S. and Europe seem promising as well, but progress is slow. We are collaborating with several technology partners; I believe there are about 18 to 25 companies in this space. We hope to identify the successful ones, but currently, it's difficult to predict who will emerge as the leaders in the SMR market.

Just to confirm, is there any reason to believe that, on a gigawatt basis, your opportunity in this area should be significantly different compared to a traditional plant? I also have one follow-up regarding the asbestos. Please continue.

Well, I was just going to say on the SMR side, I think that's a good way to state it. Even with a small modular reactor, you're still going to have pumps and valves. This can be compared to the ratio of what traditional looks like to SMR for our entire portfolio.

Perfect. And then just on the asbestos side, how are you guys thinking about packaging that up and selling it to like an insurance company or something like that? We've seen competitors and other companies take advantage of that? How does the economics of that look currently?

Certainly, that's something we take a look at from time to time. In the past, these programs have been fairly well funded by insurance, and we think well managed within Flowserve. But we're continuing to dust off that analysis and make sure that we're doing the right thing for our shareholders by continuing to manage this internally.

And we'll move to our next question from Damian Karas with UBS.

So, sorry if I missed this, hopping over a little late from another call. Just the updated full year guidance kind of on both the sales guide and just EPS. It kind of implies a pretty wide range of outcomes in the fourth quarter. Would you maybe just comment a little bit on that range and kind of the swing factors from the low end to the high end?

Sure. To clarify, our current outlook suggests we are likely to settle around the midpoint of our revenue guidance range. This is partly influenced by a specific item that affected our assessment this quarter. Achieving the higher end of the range depends significantly on revenue. At this moment, we expect a smaller increase compared to what we typically see when moving from the third quarter to the fourth quarter. This decrease is primarily attributed to lower POC revenue compared to the fourth quarter of last year, particularly from the Jafurah project. In order to reach the high end of our revenue guidance, we would need to see an exceptionally strong book-to-bill quarter or advance some POC revenue we anticipate for 2025. Thus, we are looking more towards the midpoint at this point in the quarter.

Okay. Got it. That's helpful. And then I wanted to ask you about the water end market. You had some pretty notable booking strength there. Curious if there are any large project awards that stick out? Are you just seeing broader-based strength? And give some of the unfortunate damages caused by the hurricanes in the Southeast U.S., just curious if there's any such associated drivers there, maybe factoring in?

We experienced strong water bookings this quarter, approximately $90 million, which is nearly double what we achieved last year. This was largely due to flood control and industrial wastewater projects. Our strengths lie in more complex water solutions, whether it involves managing large volumes of water for flood control or recycling and cleaning industrial waste. We also perform reasonably well in desalination, despite the increasing competition in that market. During the quarter, we secured several awards in North America, particularly in urban areas focused on waste and flood control, which is our main area of expertise. We had two notable projects in the $5 million to $10 million range and one larger desalination project in the Middle East. We are closely monitoring the desalination market, as we see significant growth potential there, although competition is fierce. We believe there are opportunities to enhance our system approach through pressure exchange technology, process improvements, RedRaven, IoT integration, and our high-energy pumps. Overall, as water becomes scarcer, desalination opportunities are on the rise. Additionally, we are noticing increased investments by local municipalities to manage weather-related catastrophes and to upgrade their flood control and industrial systems to better serve their communities.

And our next question comes from Saree Boroditsky with Jefferies.

Just to clarify, the guidance doesn't include the impact from MOGAS, but given that you have closed, could you just update us on the contribution in the fourth quarter and then to start within that for 2025. Thank you.

Sure. So just with respect to MOGAS, overall, we think this is a business that's about $200 million of revenue annually at margins that are accretive to Flowserve. If you look at the presentation, you can see the size of the valves and actuation that we're talking about as we look at them. And so, you might anticipate there is a higher percentage of POC revenue than we have on the rest of the valve’s portfolio. So, we're going to need to sort through sort of the existing backlog and shipments to understand how that $200 million would have fallen out this year under Flowserve's revenue recognition model. And so, we have stopped short of providing a guide for MOGAS as we work through those details. That said, given 2.5 months of performance, I don't anticipate that it's going to be incredibly impactful for the first quarter, and we will be able to give a good read-through based on what we see this quarter going into 2025.

Okay. That's helpful. And then just you mentioned the election, but given that it's next week, one of the items that's come up is the impact of regulation on energy projects. Could you just maybe comment on if your customers have talked about the impact of regulation? And if this is decreased, would you expect to see higher activity levels and thus sales for you?

Sure. This is the one question that I didn't want to talk about. However, I will say that there are two different parties, and one supports less regulation. Our customers in the oil and gas sector typically prefer less regulation because they believe it would allow them to advance certain projects, particularly in LNG and pipeline growth that require interconnections across the United States. We'll see what happens. Overall, Flowserve is committed to focusing on our work with customers to drive growth, and regardless of the outcomes, we believe we can continue to achieve success at Flowserve.

And our next question comes from Joe Ritchie with Flowserve. Please go ahead.

I guess I work for Flowserve now. My first question, Scott, you mentioned, look, it's great to see the aftermarket bookings above 600 in the last two quarters. You talked about the capture rates in both of the different segments. I'm curious like as you think about the runway to capture your installed base, I don't know if you want to use a baseball analogy or if you want to maybe just give us a sense for how much room there is to continue to capture more of your installed base?

Sure. I'll provide a specific example. Last week, I was in Europe with our European services and solutions team focused on pumps, and I visited one of our pump parts manufacturing locations in Italy. The team was very optimistic. Even this year, we've experienced growth in what I would describe as a fairly challenging market within the process industries in Europe. We’ve managed to increase our capture rate by a couple of hundred basis points this year, and I see significant potential to continue improving that. While we would love to report that our pump parts capture rate is in the high 70s, the reality is we are much lower, around the 30% to 40% range. With our enhanced focus on quoting quickly—turnaround times in minutes or hours instead of days—and our ability to produce parts within days instead of months, I believe we can make a meaningful impact. The team is focused on speed, and they have a metric called "Speed wins." I can say that the entire team is highly passionate and aligned with our strategy to support our customers. We are doing some truly innovative work, and I was very pleased with what I saw in Europe last week. I believe we can carry that success forward globally from a services and solutions standpoint.

Got it. That's super helpful and encouraging. And I guess maybe the follow-on question, I don't know if you guys are willing to lay out any pieces yet on the 2025 framework. But to the extent you are, I'd be curious, a, if it's just broad parameters for how you're thinking about next year?

Yes. Maybe I'll start, and Amy can jump in. Really, what we're thinking right now is we put out the 2027 targets last year. We said 5% growth when we talked about some expanded margin and then an EPS target. And we've made incredible progress over the last 12 months along that. And I'd just say, as we think about 2025, that's how we're thinking about it and just continuing that momentum, continuing to connect dots to the 2027 long-term targets.

Yes. Scott hit on it. And maybe just to touch a little bit more on the segments, and I referenced this earlier, I think that in FCD, we've seen tremendous sales growth coming from 2023 to 2024. Next year is going to be more about margin expansion and sales growth versus on the FPD side, where we're not satisfied with margin expansion, but we're pleased with the progress that we've made. So, we're focused on kind of growing that business and you see that within the makeup of our backlog currently. So maybe that's just a little bit more color for you at the segment level.

And then obviously, in the next earnings call, we'll provide full year guidance and a lot of color on how we see the outlook for 2025.

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

This is Eric Look on for Brett Linzey. Bookings growth appears to be broad-based from what it seems, except within temps. Can you maybe double-click into that and the challenges there and when we should expect a rebound in Europe? Thanks.

The chemical market has faced some challenges, particularly in Europe and to a lesser extent in the U.S. We are currently experiencing an oversupply of production chemicals. Our company remains heavily invested in the chemical industry, and the aftermarket is crucial for us. During my recent visit to Europe, I spoke with several of our customers and identified real opportunities for them to manage their businesses differently. Some exciting developments include incorporating recyclable plastics and other recyclables into their processes, which represents a shift in workflow that necessitates flow control applications. Additionally, they are focusing on improving efficiency and productivity at their existing facilities. We discussed our Energy Advantage program and our RedRaven technology for monitoring pumps and valves with them. We are also exploring new ways to enhance uptime and reliability, including longer-term service contracts rather than traditional call-outs. While the chemical sector has been challenging, I believe there are opportunities for us moving forward. On a positive note, we anticipate significant investments in the petrochemical and base chemical markets in the Middle East, with growth expected to begin in 2025 and beyond, and we are well-positioned to capitalize on that.

And ladies and gentlemen, this concludes today's question-and-answer session and concludes today's call. Thank you for your participation. You may now disconnect.