Flowserve Corporation (NYSE:FLS) Q1 2024 Earnings Call Transcript - InvestingChannel

Flowserve Corporation (NYSE:FLS) Q1 2024 Earnings Call Transcript

Flowserve Corporation (NYSE:FLS) Q1 2024 Earnings Call Transcript April 30, 2024

Flowserve Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day. And welcome to the First Quarter 2024 Flowserve Corporation Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Jay Roueche, Vice President, Treasurer and Investor Relations. Please go ahead, sir.

Jay Roueche: Thank you, Jess. And good morning, everyone. We appreciate you joining our call today to discuss Flowserve’s first quarter 2024 financial results. On the call with me today are Scott Rowe, Flowserve’s President and Chief Executive Officer; and Amy Schwetz, Senior Vice President and Chief Financial Officer. Following our prepared comments, we will open the call for your questions. As a reminder, this event is being webcast and the 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 April 30, 2024 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, and are accessible on our Web site in the Investors section. I would now like to turn the call over to Scott Rowe, Flowserve’s President and Chief Executive Officer, for his prepared comments.

Scott Rowe: Thanks, Jay, and good morning. We are extremely pleased with our first quarter results, marking a very strong start to the year. We continue to drive improvements in the business and outperformed our own expectations in the quarter. Given the excellent start to the year, we have increased our full year adjusted EPS guidance range to $2.50 to $2.70, which at the midpoint is nearly a 24% increase year-over-year. Flowserve is building on the solid momentum established over the last 18 months, driven by the implementation of our new operating model, improved execution and delivering on our ongoing 3D strategy. While we have made tremendous progress over the period, we believe there is more room for improvement and we remain committed to our 2027 financial targets that we presented last year.

Before I get into the results, I would like to thank our associates around the world that share my passion for providing flow control solutions to our customers every day of the year. Thank you for what you’re doing to make Flowserve such a great company. Looking at our first quarter results in detail. We delivered strong adjusted earnings per share of $0.58, a 45% increase over the first quarter of 2023. The progress we have made in operational excellence drove our outsized results this quarter. We generated almost $1.1 billion in revenue, which represents a nearly 11% increase year-over-year. Our 31.7% adjusted gross margin exceeded our expectations and gives us confidence in our margin progression journey. Our adjusted operating income margin of 10.9% was a 260 basis point increase year-over-year.

These strong results are notable considering that the first quarter historically tends to be more seasonally challenged. We have made significant progress improving our results and delivering a more consistent performance on a quarterly basis. The changes we implemented in the organizational design process have taken hold and are providing enhanced speed, improve decision making and further accountability within our seven business units. Additionally, our operational excellence program is gaining traction. We have now trained over 1,100 associates in our enhanced operating model focused on shop floor daily management, problem solving and material planning. The operational improvements that we are seeing today are directly linked to our ability to operate more productively and eliminate waste and inefficiency in our manufacturing processes.

We are excited about the progress within our operational excellence program, and we have clear visibility to further improvements. Additionally, as we improve our core operations, we are finding more opportunities to consolidate our global footprint and leverage the scale inherent in our business. We have also made good progress with our product management organization and processes as we have now fully defined our program and our approach. We are largely at the beginning of the product management journey but we can already see the potential with our dedicated teams and improved focus. As we advance the product and portfolio initiatives, we believe we will begin seeing the benefits of these efforts in the back half of this year and into 2025.

Overall, we are very pleased with the progress we are making and continue to believe that operational excellence as well as product management and portfolio optimization continues to deliver the 100 to 200 basis points of margin improvement by 2027 that we communicated at last year’s Investor Day event. Turning now to our bookings and market outlook. In the first quarter, our markets remain constructive and we delivered solid bookings of $1.04 billion across all industries. 3D bookings represented nearly 30% of the total and we expect our growth strategy to continue to generate significant opportunities going forward. Similar to the fourth quarter of 2023, our bookings in the first quarter did not include any large projects. Our largest award was around $12 million but we did see a modest number of smaller projects in the $5 million to $10 million range.

We were pleased to achieve our ninth consecutive quarter with bookings over $1 billion, considering the first quarter was driven primarily by our core business of aftermarket, MRO and short cycle activities. This core business remained very healthy in the quarter as customers continue to spend money to support higher facility utilization and avoid unplanned downtime with their operations. We are seeing these elevated trends across most of our end markets. Aftermarket generated more than $575 million in bookings, roughly a $25 million increase sequentially and year-over-year, further highlighting the continued demand from customers to keep their assets running and productive. We have now delivered six quarters in a row over $550 million in aftermarket bookings.

Our global network of Quick Response Centers, combined with our commitment to serve customers with speed and high levels of service continues to ensure our aftermarket franchise remains a competitive advantage. While project bookings were comparatively light in the quarter, we recently announced two large project awards in April that together exceeded $150 million. The awards support the aggressive capital build out in Saudi Arabia for Phase 2 of the Jafurah gas production facility in the Amiral greenfield petrochemical facilities. We have extensive experience in the Middle East and have strong, long standing relationships with these EPC customers and the end user. Additionally, both of these projects will have significant aftermarket entitlement with mechanical seals, pump parts and services that we are fully prepared to capture given our local presence and strong customer relationships.

Furthermore, we won both of these projects with a more disciplined, selective bidding process that should deliver better execution and enhanced marginality commensurate with the complexity of this type of work. The value of these awards will be reflected in our second quarter results. Looking now at bookings by end market. Our traditional markets remained healthy in the quarter, including bill and gas and chemicals. While most of our end markets were comparable in dollar size to last year, we were pleased to deliver 7% growth in our power bookings. This is an industry that is beginning to look more attractive for Flowserve. Power demand in mature markets like Europe and North America has been reasonably flat for several decades. However, with the ongoing electrification trend and now the substantial growth in data centers to support energy intensive AI processing, the demand for electricity is projected to grow significantly over the next decade.

Flowserve has considerable exposure to the power industry and has generated roughly $450 million per year in traditional energy like coal, natural gas, hydroelectric and nuclear where water and thermal management is critical as well as new forms of power generation, such as concentrated solar power, wind and hydrogen with advanced flow control equipment. We expect there will be a meaningful investment in capacity expansion and new generation in the years to come across all forms of power generation, renewables, hydrocarbon based and nuclear power. We are excited about the potential growth in the power sector and we are well prepared to capitalize on this growth with both new equipment and aftermarket parts and services. As we look ahead, our market outlook remains positive.

Our MRO business and aftermarket franchise remains strong as we expect existing refining, chemical and power facility utilization will likely continue at high levels for the foreseeable future. Furthermore, we are encouraged that our 12 month project funnel is up 10% year-over-year including a 25% increase in both the energy transition and power markets. We will continue to remain selective in the larger projects that we pursue to ensure that we can successfully deliver for our customers and drive the appropriate margins for Flowserve over the full life cycle of the project. From a regional perspective, we have continued visibility into project opportunities in the Middle East as well as Asia Pacific and South America. From an MRO and aftermarket outlook, we are seeing ongoing strength in North America and we are beginning to see more positive signals from our European customers.

We believe the macro environment and outlook remains favorable for the flow control space. Like everyone in the industry, we continue to monitor geopolitical unrest that is causing concerns in various parts of the world. But at a high level, we remain optimistic about our overall outlook and we see positive signals driven by key global megatrends from energy transition and decarbonization, to energy security and regionalization to electrification and power driven in part from AI and data centers. As we’ve seen each quarter over the last few years, our book-to-bill ratio will vary quarter-to-quarter. But we continue to expect that our full year book-to-bill ratio in 2024 will exceed 1.0 and that we’ll exit the year with a larger backlog than where we began the year.

This backlog visibility provides support for continued revenue growth into 2025. I will now turn the call over to Amy to address our first quarter results in greater detail. Amy?

A group of industrial workers in coveralls operating a large scale pump system in a factory.

A – Amy Schwetz: Thanks, Scott. And good morning, everyone. As Scott has outlined, we delivered very strong first quarter results and, in some cases, record performance that continued our positive momentum, driven by strong backlog conversion, margin enhancement and cost control as well as by improved working capital efficiency, we generated record operating cash flow for the first quarter at $62 million. We truly appreciate our associates’ efforts and dedication, which helped us achieve this positive outcome. We also generated the highest sales levels for our first quarter in more than 10 years, drove adjusted operating margin to 10.9% and delivered adjusted earnings per share of $0.58. Our adjusted operating margin increased another 40 basis points sequentially from the seasonally strong fourth quarter levels, further demonstrating our continued progress towards our long term financial targets.

Our reported earnings per share was $0.56, which included only $0.02 of net adjusted expenses, highlighting the quality of our earnings and cash generation this quarter. Altogether, we are off to a very encouraging start to 2024. The strength of our first quarter results and positive outlook for the remainder of the year resulted in an increase to our full year adjusted earnings guidance range to $2.50 to $2.70 per share. At the midpoint, this represents a nearly 24% increase compared to last year. Let me provide some color on the phasing of our guidance for the balance of the year. We have taken steps to smooth the seasonality of the business. This includes our performance on projects like the first phase of the large Jafurah project where we delivered the highest quarterly revenues in the first quarter that we expect from the project of the year, serving to remove some of the large calendar swings in our business.

And although we still expect the fourth quarter to be our highest sales and earnings quarter of the year, we expect less differentiation in revenue from the first quarter to the second and third. The $150 million plus of project awards we announced last week have potential to provide some incremental contribution in the fourth quarter. And as Scott mentioned, our continued progress on operational excellence and product management should also provide opportunities for margin expansion in the second half of the year. Let me now turn to the quarter in greater detail. With our improved performance, we delivered revenue of $1.1 billion, an 11% increase over the prior year, comprised of FCD’s and FPD’s growth of 14% and 10%, respectively. We also generated strong top line growth in both original equipment and aftermarket with revenue increases of 14% and 8%.

We were very pleased to see all regions contribute to our double digit sales growth with notable year-over-year improvement in the Middle East in Africa, Europe and North America of 28%, 18% and 8%, respectively. Shifting to margins. We generated adjusted gross margins of 31.7%, the highest level in four years and representing a 130 basis point increase year-over-year. This margin improvement was driven by our enhanced operating model and ongoing focus on operational excellence. We expect this in combination with our product and portfolio optimization efforts will expand margins even further as we progress towards our 2027 target level. By segment, we were particularly pleased to see FPD realize a 32.9% adjusted gross margin, representing a 100 basis point year-over-year improvement despite significant revenue growth from original equipment.

On a reported basis, the first quarter consolidated gross margins also increased 90 basis points to 31.2% despite net adjusted items within cost of sales increasing by $4.3 million versus the prior year. First quarter adjusted SG&A increased about $7 million compared to last year to $229 million. Despite this dollar increase, adjusted SG&A as a percent of sales declined by 150 basis points year-over-year to 21.1%, driven by the strong top line leverage during the quarter and our ongoing cost control actions. On a reported basis, first quarter SG&A decreased year-over-year by $16 million to $228 million, driven by lower realignment expenses as part of our operating model implementation. Our adjusted operating income in the quarter was $118 million, an increase of $37 million year-over-year, which delivered an adjusted operating margin of 10.9%, a 200 basis point expansion with an incremental margin of 35% year-over-year.

As I noted earlier, this quarter’s adjusted operating margin was also 40 basis points higher than what we delivered in the fourth quarter of last year, demonstrating that our improving operating cadence has minimized the sequential top line reduction. These results should position us well in our path to our 2027 adjusted operating margin target of 14% to 16%. At the segment level, FPD led the way by delivering its highest adjusted operating margin since the formation of this segment in 2019, which at 14.9% marked a 270 basis point year-over-year improvement. FCD also increased its adjusted operating margin by 30 basis points compared to last year. FCD typically has the greatest variance in operating margin between its highest margin quarter of the year and its lowest, which is largely a result of product mix.

In the first quarter, this weighed on FCD’s margin and it will likely continue to do so in the second quarter, but we expect to see significant margin improvement in FCD’s adjusted operating margin during the latter half of the year. On a reported basis, first quarter operating margins increased significantly some 460 basis points year-over-year to 10.4% benefiting from the $19 million reduction in adjusted items as well as realized margins within our FPD and FCD segments. Operating leverage further contributed to the improvement. Our first quarter reported and adjusted tax rates were approximately 20.5% and right in line with our full year tax rate guidance of roughly 20%. Our ETR in 2024 is expected to be higher than a year ago when we saw the release of discrete valuation allowances in certain jurisdictions.

Turning now to cash flow. We delivered a first quarter record with operating cash flow of $62 million, driven by earnings growth and improved primary working capital as a percentage of sales. Our cash conversion cycle accelerated by approximately 13 days compared to the first quarter of 2023. As a percent of sales, we improved our first quarter adjusted primary working capital by approximately 440 basis points to 28.4%. After experiencing higher working capital needs for much of the last 18 months, we are pleased to continue reducing our working capital investment as a percent of sales closer to our target of 25% to 27% as our planning capabilities improve and supply chains and lead times further normalize. Capital expenditures were $14 million during the quarter, which when subtracted from operating cash flow, also brought free cash flow to a first quarter record at $49 million.

The first quarter also saw uses of cash of $28 million for dividends following our 5% increase in the quarterly dividend and a $15 million term loan reduction. We also restarted our share repurchase program this quarter for the first time since 2021 as we begin to deliver on our capital allocation commitment from the 2023 Investor Day of buying back at least the sufficient number of our shares annually to offset equity compensation dilution. As we look to other potential uses of cash in the year, the opportunities in our inorganic pipeline continue to be very robust. We remain interested in targets that drive long term returns by further accelerating our 3D strategy, providing opportunities to leverage our scale and allow for effective integration with our broader business while meeting our financial criteria, namely, the expected returns must exceed our average cost of capital as well as be margin and cash EPS accretive.

While we are actively looking at several opportunities currently, we will maintain our discipline. When considering the strategic use of capital, our enduring framework aims to continue to direct investment dollars to the highest long term return options regardless of the alternative. In closing, we are proud of the results we delivered this quarter. We see opportunity for continued margin improvement and earnings per share growth moving forward and we are intently focused on achieving those objectives. Let me now return the call to Scott.

Scott Rowe: Great. Thank you, Amy. Let me now offer a few comments on our 3D strategy. We remain committed to further diversifying the portfolio into attractive markets like specialty chemical and water in supporting existing customers and their energy transition initiatives, as well as participating in new energy technologies like hydrogen. We have made significant in roads with our 3D strategy and we believe that it will continue to drive outsized results in the current environment. While we are well suited to serve our customer base today, we are continuing to invest in our product and service offerings, including through potential inorganic opportunities that further build out the portfolio to support these diverse markets and the new emerging sources of energy.

Let me spotlight a few 3D examples from the first quarter. I’ll start with Diversify, where our bookings remained very healthy in the first quarter of 2024 as we continue to apply our portfolio into end markets that present an above average growth profile. During the quarter, we were awarded a contract from a major international chemical company to supply our valve technology for their specialty chemical smart plant of the future located in China. This award brings valve and actuator bookings on this project to over $50 million as we secured frame agreements for control valves and automated ball and plug valves throughout the facility. We utilized our project life cycle support program to secure a larger portion of this project, bringing feed support, project management, installation services and long term operational support to the customer.

This award is just one example of our efforts to further diversify and increase our exposure to the growing specialty chemical end market. In decarbonize, we generated solid bookings, including several small projects awards in nuclear and the LNG markets. Over the past few years, we have had success with several first of its kind carbon capture and storage or CCS projects. During the first quarter, Flowserve was awarded another contract for a new CCS facility in Europe. By supplying both pumps and valves, Flowserve demonstrated the power of our comprehensive flow control portfolio. The project will capture CO2 from several different industrial facilities in the region, which will then be transported and pumped into empty natural gas fields beneath the North Sea for permanent storage.

We are excited to provide the critical flow control equipment for the substantial and impactful project. Lastly, on digitize, we believe our ability to digitize our products and leverage our large installed base and aftermarket capabilities with our Red Raven IoT offering will better position Flowserve to provide true solutions for our customers through monitoring and predictive analytics. We are instrumenting our pumps, seals and valves to better optimize our customers’ facilities. In the first quarter, we added nearly 100 assets to the Red Raven monitoring portfolio and now have 25% more assets on the platform than this time last year. We also received an award to monitor failsafe electric actuation in a critical service environment. Over 50 of our Limitorque electric actuators were seamlessly integrated with our Red Raven solution and are destined for an offshore wind project in Norway and will receive ongoing condition monitoring from Flowserve.

In conclusion, our first quarter results, combined with our outlook and expectations for the rest of 2024, should position Flowserve incredibly well for the rest of the year and support the increase in our full year adjusted EPS guidance. We are confident in the macro themes of energy security, energy transition and increasing power demands, and we are well suited to capture both large projects like the $150 million plus awards we booked in April, and further grow our higher margin aftermarket business and MRO activities supporting our large installed base. We are excited about the opportunities ahead of us to profitably grow our business and we are more optimistic today in our ability to deliver at least 150 basis points of full year operating margin improvement in 2024 compared to last year.

Over the longer term, operational excellence, including roof line consolidation, combined with our product and portfolio management, should drive our operating margins even higher. We believe we’re in the early phases of these initiatives and we have a clear path to achieving the commitments we presented at last year’s Analyst Day. Overall, our strategy is working and we remain committed to further capitalizing on opportunities in the market today and into the future to deliver long term value creation for our customers, associates and shareholders. Operator, this concludes our prepared remarks. We would now like to open the call to questions.

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