FLS - NYSE

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 the 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 multiyear up cycle 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 greater detail. We are very pleased with our performance and with the continued execution improvements in both our segments during the period. In the second quarter, we delivered $0.52 of adjusted EPS on revenue of nearly $1.1 billion which is our highest level of sales since 2015. The strong results we've produced in the first six months of 2023 coupled with the operating momentum we have demonstrated over the last several quarters provide us confidence in our ability to execute on our sizable backlog to drive year-over-year revenue and earnings' growth in the second half of the year and also set us up well for 2024. On a reported basis our earnings per share for the quarter was $0.39 primarily impacted by realignment and FX charges. Velan acquisition costs and additional charges related to a previously reserved sales contract comprise the remainder. Together, these expenses resulted in a total of $0.13 of adjusted items. Our second quarter revenue increased over 22% year-over-year with contributions virtually in all areas. Original equipment and aftermarket revenues increased roughly 26% and 20%, respectively compared to the prior year. At the segment level, FPD contributed original equipment and aftermarket growth of 34% and 20%, respectively while FCD delivered both original equipment and aftermarket growth in the 18% to 19% range. From a regional perspective revenues increased across the globe year-over-year with notable strength in the Middle East and Africa region as well as in Latin America where sales were up 56% and 32%, respectively while North America and Europe were up roughly 19% and Asia Pacific contributed 7% growth. Turning to margins. We delivered solid year-over-year improvement again this quarter. Adjusted gross margin increased 190 basis points to 30.3%. This increase was driven by the strong volume leverage produced by our operational execution, a greater contribution derived from our recent price increases and an improving supply chain environment. The positive tailwinds were partially offset by the continued recognition of lingering lower-margin backlog that was booked in tough market conditions. In addition, we are seeing the impact of increased compensation expense due to our annual merit increase and higher year-over-year performance-based expense accruals reflecting our results this year compared to 2022. All-in, we are very pleased to have delivered 30%-plus gross margins in the first half of the year, which is a level we believe we can sustain for the back half of 2023 and look to grow from in the future. Going forward our actions and initiatives are designed to maintain a high level of gross margin performance. This includes increasing the margin profile of work coming into backlog, continuing to improve our execution on the shop floor and implementing on our previously announced $50 million cost-out program, which includes a comprehensive organizational redesign to improve accountability, speed, product focus, planning competencies and our ability to address changes in the business outlook more quickly. On a reported basis, second quarter gross margins increased 160 basis points to 29.9% where the improvements previously discussed were partially offset by a $4 million increase in adjusted items, primarily due to higher realignment charges versus prior year. Second quarter SG&A increased $27 million to $219 million, primarily due to increased performance-based compensation accruals compared to last year as well as a higher level of R&D investment to further expand our 3D product offerings, partially offset by a $4 million reduction of costs associated with the discrete legal matter. Most importantly adjusted SG&A as a percentage of sales decreased 150 basis points to 20.2% as we successfully leveraged our higher revenue level and realized some of the early benefits from our 2023 cost-out plan. Except for the occasional fourth quarter, this quarter's SG&A percentage is the lowest level we have delivered since 2015. As we grow revenues and maintain our cost focus, we would expect to be in this range or better. On a reported basis second quarter SG&A increased $35 million to $230 million. In addition to the items just mentioned, the reported amount also included an $8 million increase in adjusted items primarily due to a $7 million increase in realignment expense compared to prior year and $3 million related to the Velan transaction. Despite the increased year-over-year amounts, reported SG&A as a percent of sales declined 80 basis points to 21.3%. Our second quarter adjusted operating margin increased 320 basis points to 10.4%, reflecting our strong operational performance, less frictional costs, and ongoing SG&A control. At the segment level, strong performance at FPD and FCD delivered adjusted segment operating margins of 13.2% and 13.3%, respectively. This represents year-over-year improvement of 380 and 80 basis points, respectively. Second quarter reported operating margin increased 210 basis points year-over-year to 8.9% where significant operating leverage was partially offset by the $13 million increase in adjusted items versus the prior year. Our adjusted tax rate was 26% in the second quarter. This is much higher than our full year guidance range and was primarily due to the geographical mix of income and the timing related to certain foreign tax credits. Considering the second quarter's rate, we now expect our full year adjusted tax rate to be approximately 20%. Turning to cash flow. We are pleased with the first half operating cash flow of $50 million, especially since the first half of the year is traditionally challenged. With our performance in the first six months of 2023, we have produced a $122 million improvement versus the first half of last year, which is primarily due to our higher earnings' level and a $90 million year-over-year reduction in cash used for working capital. We delivered a year-over-year improvement from an inventory perspective as well. Inventory including contract assets and liabilities for the first half was a use of $78 million versus the prior year use of $95 million. Despite the significant increase in revenues, we delivered a $16 million decrease in cash used for receivables. So I'm pleased with our collection efforts which produced a modest improvement in our Days Sales Outstanding. We will continue to focus on improving our cash conversion cycle, which has been necessarily challenged over the last several quarters by our rapidly growing backlog as well as an improving, but still elevated lead times causing some lingering challenges -- caused by some lingering challenges in the supply chain. As a percent of sales, primarily working capital supporting our recent bookings and backlog growth declined modestly 90 basis points, on a sequential basis to 31.9%. While our backlog has increased over 20% since the second quarter of 2022, our inventory including contract assets and liabilities as a percent of backlog, has dropped 130 basis points to 30.7%. We will continue to focus near-term on reducing our working capital investment, to a level below 30% of sales, driven by supply chain improvements and our more consistent and predictable execution. In addition to working capital, other significant uses of cash in the second quarter included $26 million in dividends, $17 million in capital expenditures and a $10 million term loan debt reduction. As pleased as we are with the year-over-year improvement in free cash flow during the first half of 2023, we continue to expect our traditional cash flow phasing this year, as that will produce the vast majority of this year's free cash flow and a seasonally strong second half primarily in the fourth quarter. Turning to our outlook for the remainder of the year, we expect to continue our recent healthy operating performance further capitalize on supportive end-markets and deliver solid second half adjusted operating margins and adjusted earnings per share. Additionally, we remain on track to achieve $50 million of full year run rate cost savings by the end of the year, through our organizational optimization strategy. As a result of the actions taken in the first half of the year, we have achieved roughly $16 million of full year run rate savings and are already seeing wins through the new organizational design including more efficient streamlined processes, better accountability and increased focus on our product and service offerings. With our near-record backlog of $2.8 billion in constructive end-market environment, we now expect to deliver revenue growth in the 16% to 18% range including a modest currency benefit, given the weakening of the US dollar since the year began. We have also increased our full year expected adjusted EPS range to $1.85 to $2, which incorporates our strong first half results and our expectations for a solid second half of the year. The midpoint of our range represents a year-over-year increase in adjusted EPS, of 75%. Of further note, our guidance metrics including the revenue and adjusted EPS target ranges do not include any impact from the expected acquisition of Velan. Our adjusted targets also exclude identified realignment expenses of approximately $40 million as well as potential items that may occur during the year such as below-the-line foreign currency effects and the impact of other discrete items such as acquisitions, divestitures, additional realignment opportunities, special initiatives, tax reform laws et cetera. Including the identified realignment spending and our other first half adjustments, we continue to expect our reported EPS in the range of $1.40 to $1.65. Both the reported and adjusted EPS target range also assumes recent foreign currency rates reasonably stable commodity prices, no significant geopolitical disruptions and expectations for the end-market environment to remain supportive at the current levels. We also expect net interest expense of approximately $60 million and an adjusted full year tax rate of approximately 20%. Finally, in terms of phasing for the remainder of the year, and considering our expected shipping cadence, we expect our third quarter adjusted earnings to align closer to our first quarter results, but we expect to finish the year with a robust seasonally strong fourth quarter. Our updated range reflects the positive momentum we have created over the last three quarters and increased confidence in our planning and execution. Let me now return the call, to Scott.

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 de-carbonization 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 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 de-carbonization 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 digitize, 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 offerings 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 time line. 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 like -- and we would now like to open the call to questions.

Of course, thank you. [Operator Instructions] And we will go ahead and take our first question from Nathan Jones with Stifel. Please go ahead.

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 -- or divided pretty starkly 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 at 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 pool, 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-partner 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?

Yeah. The energy transition, we categorize energy transition and new energy together and that was $54 million in the quarter and that's the highest that we've had thus far. And so we're pretty excited about that category. And generally what would be in there is some of the carbon capture hydrogen and other things. And so we're pretty confident that we can continue to grow that. We're excited about what we see there. On the new player front it's similar. We booked $50 million of nuclear work in Q2. That's a good number for us. And what I would say, we see that outlook in our funnel right now has doubled. And so we have good visibility to future work. We've got a really nice portfolio with nuclear and that's both on the pumps and valve side and we've got some strategic initiatives that will help us not only on the traditional power, but on some of the small modular reactors in the new nuclear as well. And so this is a growth area that we're very excited about. We see opportunities in Eastern Europe. We see opportunities in Western Europe. We see opportunities in Asia, predominantly in India. And then where -- what we see in the Americas is really around life extensions. And with our installed base within nuclear both on the valve and pump side, any time there's an extension of life for the nuclear facility, we get substantial aftermarket work. So this is something we'll talk more about in the Investor Day. We'll talk more as we go forward, but it's an area that we're very excited about for the future.

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 piece of business relative to the total?

Let me talk on the lithium mining. And so any time there's mining there's substantial water involved and we've got pumps and valves that work in the mining application handling water. And so especially on the lithium it is a high water mining operation. And so we're pretty excited about what we see in the funnel in terms of providing the high-efficiency pumps in the lithium mines plus some of the valve work and then the mechanical steels as well. And so that's only opportunities. And I'd just say part of the energy transition right as folks are looking to more of these battery and these rare earth minerals to provide the energy storage, we see a lot of work in the funnel for this type of activity. And then on Velan I said it in the prepared remarks we're working with all the authorities around the world. We've gotten approvals everywhere with the exception of France. It's a difficult process in France. We're working with the Defense Ministry, the energy ministry it's not necessarily anti-competitive. It's more about national security and the way France is moving forward. And so we're going to work diligently with them. We're answering all of your questions. We are very hopeful that we can get through this, but we are committed to the process and we'll continue to answer questions and hopefully in the next -- the coming weeks we'll be able to provide more clarity towards target 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 might have missed this, but you were emphasizing the absence of big projects in the quarter. Did you miss any just -- was there not that many to bid on? Was there any selectivity kind of your win rate there? Just some color for starters.

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 -- you 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?

Sure, Deane. Yes the aftermarket bookings at 591 are at record levels are up 12% year-over-year. And it really is a combination of things. And what we're seeing is this underspend in the COVID year. So I think 2020 -- through 2020 kind of at the beginning of 2022 there's a lot of catch-up going on there. And then also a lot of these assets are performing at really high utilization rates. And so as they're wearing through pumps valves and seals we're starting to pick up more work. And then finally we've really put a lot of effort around what we call our services and solutions business, which is what supports the aftermarket. And so this is life cycle agreement contracts this is a significant focus on lead time reduction in our coding, lead time reduction and delivery of parts. And so this focus is now paying off. And so we call our win rate, we call our entitlement and what we're seeing is that our entitlement is actually coming up as we convert this higher level of work. And so we're winning more market share. There's more activity out there. And then the last point and it's an important one there is substantial work around compliance that's happening all over the globe. And so as different regulation comes through or a company changes their standards for emissions then there's aftermarket opportunities for us. And so we see that in the seal side, we see it in valves, we see it in pumps as well and so some of this change in regulation in company standards is also helping to drive our aftermarket growth. And just before I get off the topic, I'd just say, we track this on a daily and a weekly basis. We've got good visibility to that aftermarket work around the world. And at this point we're not seeing any signs of slowdown and so we'll continue to be vigilant about that. But we – at this point, we firmly believe that we can keep this level of activity going 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 attractive – or 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 was good and I said this in the prepared remarks, we've seen the project funnel grow year-to-date. We're above where we were last year with the project funnel. And last year the funnel included the Jafurah project at $200 million plus. And so we think -- we like what the project funnel is showing us. And then in terms of kind of areas where we've seen substantial growth nuclear is up significantly. LNG is up significantly and then the whole decarbonization and new energy is up significantly. From a regional perspective, the Middle East is the highest and we're seeing significant opportunities in the Middle East. And then we're seeing -- and those would be more traditional both the downstream refinery and the chemical business. And then in Asia, we still have good visibility to new projects, but those are more competitive and harder to win than what we have in the Middle East or in North America. And so overall, I'd say it's reasonably well balanced between some of the new stuff and what we've seen in a traditional fashion. And again, I feel confident in our ability to win. And I feel like as the market continues to move forward the pricing dynamic will get better and we'll start to see more wins on the OE side. But right now, we're in a good position. The backlog allows us to be more selective. We're being disciplined in that approach, but I feel like we can continue to grow OE 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.

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 flat line 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?

Yeah. Let me -- I had bookings revenue and margins as we think about 2024. Right now kind of based on the commentary and the outlook in the project funnel and where our aftermarket and MRO is, we expect modest bookings increase in 2024. I don't think you're going to see what we saw last year that 15-plus percent across the board, but I think we're going to see modest growth. And the activity is there. And I think we've been pretty selective on some of this bigger work and we have the ability to go down. But at this point, there's no reason to do that to win more work given where the backlog is. And so, I feel like we can go forward with the OE side and I don't see the MRO and aftermarket going down either given the utilization rates in some of the what I said before on the compliance changes in the regulatory environment. Now what could go wrong? I mean, anything that's driving a hard recession or a change in the outlook of the economy, obviously impacts this business. And so, could that happen? Sure. At this point though given the pullback in 2022 or 2020 and 2021, I just don't see that given the substantial underinvestment in these end markets and so I think there's growth for us for the next couple of years. We can see that in the general indices out there. A lot of the oil and gas companies have talked about their willingness and need to spend. We're seeing it in the international side. And then, when we think about the two big drivers for us right now it's this energy security which nations and countries are desperate to secure their energy source that's number one. And then the de-carbonization effort, that's number two. And so, I don't see either of those reversing course and I think there's only going to be more investment to make sure that they can secure their energy and then decarbonize existing assets. So I feel good about it. And then, when we look about let's go to revenue for 2024. Again, we're positioned pretty well there given the backlog that we have and the ongoing bookings And so bookings would have to decline pretty substantially. I'm looking at Amy for a number here. I'm not going to throw out a number, but they'd have to come down pretty significantly from where we are today cannot have revenue growth in 2024. And so we feel like -- in multiple environments we still grow the company into 2024. And then Amy laid out our margins, right? And so again, we feel we're very well positioned both, in the short-term and the medium and long-term to continue to drive gross margin expansion into 2024, and I won't walk through the list that she mentioned earlier. But right now, we feel like we're as well positioned as any of the peer group in terms of being able to drive bookings' growth revenue growth and margin performance into 2024.

Yeah. Damian I'd just use it as a data point that when we started the year with a smaller backlog than we have today, we had guided initially to 6% to 8% revenue growth and we had a number of people point out that that decline did -- or that that implied a negative kind of book and burn business in terms of -- from a growth perspective in 2023. So, the backlog is -- really gives us a lot of insight into what 2024 can and should look like kind of regardless of the macro environment at that point in time and it's our job to capitalize on 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 x million dollars 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. I'd say the enablement and what it's going to give us we'll do that at the Analyst Day. So that will -- we're going to hit that head on and commit to some longer-term targets and exactly what could be attributed to the reorg. But the reorg itself fundamentally, what it did is it took us to two major divisions. In the past, we had three leaders that one was leading the aftermarket business. But what we did below that, which is really important, we now have seven business units with business unit leaders. And so think about like the business unit would be industrial pumps, our seal business, the engineered isolation valve business is now a vertical and -- with a VPG and leader. And so before -- as we went through Flowserve 2.0, we had a pretty heavy structure at the corporate level truly defining process and standards around the organization. And now as we evolve to this new organization, we can slim down the corporate functions in terms of process and control. What we're now doing is really putting the honest and the accountability level at the seven BUs across the organization. So we're really excited about what it brings. It's a more customer-focused organization and then it drives simplicity across the entire Flowserve enterprise. It drives accountability for our results and then it will lend itself to some cost out that we talked about previously.

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

Thank you.

Thanks.

Our next question will come from Andy Kaplowitz with Citi. Please go ahead.

Hi. This is Piyush [ph] on behalf of Andy. Good morning, guys.

Good morning.

You guys touched on seeing good investments across recyclable and circular economy we're definitely hearing more about this. So maybe, can you comment on how impactful or how big of an end market can this be for Flowserve?

Sure. We've been fortunate to participate in a lot of the early big wins on the recyclable side and we've got some great partnerships. One that we announced is with Clariter that's truly doing a green recyclables back-to-base materials including crude-grade oils and waxes. And so, we've had a front row seat now and it's interesting to watch this evolve, but I would be reluctant at this point to say, what the overall potential is, but we have is one of our three biggest growth opportunities within the decarbonization lane. And so we're very excited about it. It lends itself well to our portfolio of valves and pumps. And so when you're breaking down plastics, it requires high heat, there's a caustic component to it. And so, it allows us to provide more of an engineered solution. And then as Amy said earlier, the other thing that we're doing with these companies is a lot of them are relatively small or early in their inception and we're actually being -- we're helping them substantially scale their companies by helping them look at their flow control or their flow loop in terms of efficiency and using the right equipment and driving an optimal flow loop for the recycle process. So this is something that we're pretty excited about it. We will talk about it as an end market in the Investor Day. But at this point, I'm not prepared to talk about what the overall potential is, because it's evolving so quickly.

Got it. Helpful Scott. And lastly on China, relatively small end market for you, but we have been hearing some cautious comments. So can you elaborate from Flowserve's perspective what you're seeing in that region?

Yes. I think cautious is probably a good word for China right now. It's not a huge part of our overall business, but it is a business that we'd like to continue to grow and be involved in. But I would say this emerging from COVID we had some higher activity last year. It's kind of flatlined thus far this year. We do have visibility to some larger projects. But right now, we're seeing those get slid to the right and delayed a bit. So I'd just say, relatively cautious view on the Chinese end market. But overall Asia Pacific for us, we still feel that we can grow our business there.

Got it. Appreciate all the color. Thank you.