Flowserve Corporation

Good day and thank you for standing by. Welcome to the flow serve second quarter 2021 conference call. At this time, all participants are in a listen only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. And I'd like to hand the conference over to your speaker today, Mike Mullen, Director of Investor Relations. Please go ahead.

Thank you, Christina. And good morning, everyone. We appreciate you participating in our conference call today to discuss FlowServe's second quarter 2021 financial results. On the call with me this morning are Scott Rowe, FlowServe's President and Chief Executive Officer, and Amy Schwetz, Senior Vice President and Chief Financial Officer. Following our prepared comments, we will open the call for questions. And as a reminder, this event is being webcast, and an audio replay will be available. Please also note that our earnings material is due, 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 6, 2021, and they involve risks and uncertainties, many of which are beyond the company's control. We encourage you to fully review our safe harbor disclosures as well as the reconciliation of our non-GAAP measures to our reported results, both of which are included in our press release and earnings presentation and are accessible on our website at flowserve.com in the investor relations section. I would now like to turn the call over to Scott Rowe, Flowserve's President and Chief Executive Officer, for his prepared comments.

Great, thank you, Mike. Good morning, everyone, and thank you for joining our second quarter earnings call. We are pleased with the performance and solid results in the second quarter, including adjusted EPS of 37 cents, which represents a 32% sequential improvement and reflects our continued transformation progress. We are encouraged by our bookings of $953 million, which is nearly an 18% year-over-year improvement. At this level, Q2 was a momentum-building quarter for FlowServe, as our bookings inflected upward, and we now have clear line of sight to earnings growth. The higher level of bookings and our improved operational performance have provided us the confidence to raise our outlook further for the full year. Our revised adjusted EPS guidance is now $1.45 to $1.65 for 2021. Since the start of the pandemic, we indicated that recovery in our end markets was expected to be directly correlated with the progress being made with COVID-19. Each country and geography are at different stages in fighting the pandemic, but on a global basis, a clear pattern has emerged. As countries roll out vaccines, COVID cases decline dramatically, and then mobility and consumption begin to improve. This in turn drives customer spending for nearly all of our end markets. We are confident in our ability to continue to grow the post-serve enterprise and ultimately restore our bookings to pre-pandemic levels in the coming quarters. There are several factors that contribute to our confidence in the outlook. First, we expect to continue to grow our MRO and aftermarket bookings. As countries emerge from COVID, we are seeing higher utilization rates in our customers' facilities, which necessitates increased parts, replacement units, and service activities. Additionally, our distribution partners are just now beginning to replenish their inventory levels. After about six quarters of destocking, we are now expecting these distributors to rebuild their inventory levels over the coming quarters. Second, we believe major project activity will emerge and begin to recover in the back half of 2021 and into 2022. In the early part of last year, we had very good visibility to a significant amount of project activity that was expected to be awarded during that year. Most of those projects were put on hold as operators were both assessing the COVID impact and reducing their capital spending budgets. Today, we are working with many of those same customers to bring those projects forward. As the economic environment has improved dramatically over the past several months, And additionally, our activity with EPCs has increased significantly this year. Finally, we see energy transition theme as a significant opportunity for CloseServe. To date, actual spending in this area is still very modest, but we expect it to grow substantially in the quarters and years ahead based on the commitments that our customers are making, as well as from the potential for increased regulation and costs associated with emissions. FlowServe is no stranger to this type of work, and I'll talk further about this growing market later in the call. Even as the outlook and trends look promising, predicting the exact timing associated with these opportunities is still challenging. The Delta variant is causing concerns for FlowServe operations and for our customers. We have remained diligent and focused on our safety protocols, and we have successfully limited pandemic impacts at most of our global facilities during the quarter. The recent upturn in COVID cases in the Americas due to the Delta variant has the potential to impact our return to office. However, we do not believe that the latest COVID trends will negatively impact our business and growth outlook at this time. Unfortunately, we did experience significant disruption in our Indian operations during the quarter. As a reminder, we have three large manufacturing facilities in several smaller locations in India. The good news is that we have seen tremendous improvements over the past several weeks, and we are currently operating at about 80 percent associate participation in these facilities, which is up from 20 to 30 percent participation that we experienced for most of the second quarter. Our Indian-based suppliers were also challenged in the quarter, which presented modest headwinds for us, but our supply chain team has done a good job mitigating the impact and leveraging our global suppliers to minimize disruptions. Let me now turn to our second quarter bookings. We are pleased with the 17.9% year-over-year increase, which brought this quarter's total bookings to $953 million. Both original equipment and aftermarket bookings grew in the 17% to 19% range. We were very pleased to have delivered almost $525 million of aftermarket awards this quarter, returning to pre-pandemic bookings levels for this part of our business. Each of our core end markets delivered year-over-year growth, with the biggest drivers being oil and gas and chemicals, which increased 39% and 19%, respectively. On a regional basis, we saw solid growth across the globe, with the exception of the Asia-Pacific market, which was negatively impacted by India's COVID resurgence and a more difficult compare period. Our bookings performance this quarter was driven almost exclusively by our aftermarket and MRO business, which represented a large volume of small awards. In fact, we only secured one award that exceeded $10 million, where FCD booked a $12 million nuclear power order in North America. To achieve this level of bookings without any large projects in the mix is an encouraging sign for future growth. We expected larger project spending to lag aftermarket in MRO work, and it has. And we are now confident in the return of project investment later this year and into early 2022 across our end markets. Our project funnel continues to grow and is up nearly 25% compared to this time last year. driven by the feedback we obtained from customer discussions, insights gained from EPC bidding and backlogs, and our interaction on the delayed projects which we originally expected to be released in 2020. We continue to anticipate bookings in this $950 million range in this year's third and fourth quarters, assuming continued progress with COVID. At this level, we should see significant bookings growth in the next two quarters, relative to the 2020 comparative periods. Delivering these level of bookings or higher would position FlowServe well to deliver a strong 2022 financial performance. Our results this quarter also helped drive strong first half results for 2021. Our adjusted decremental margins for the first six months was just 13% with our improved market outlook. We remained focused on returning FlowServe to growth while driving margin expansion and increased returns. I would now turn the call over to Amy to cover our financial results in greater detail.

Thanks, Scott, and good morning, everyone. Looking at FlowServe's second quarter financial results in greater detail, our reported EPS of $0.35 increased significantly over the prior year period. In addition, the quality of our earnings also improved. with after-tax adjusted items declining from $61 million in the prior year period to just $3 million this quarter. Our adjusted EPS of 37 cents excluded just 2 cents of net items, including realignment expenses, below-the-line FX charges, and a gain on sale of business. We were pleased with these results, particularly considering the impact of COVID-related headwinds of about 2 cents primarily from our Indian facilities, as Scott discussed. Second quarter revenue of $898 million was down 2.9%, or 7.1% on a constant currency basis. The decrease was primarily due to the 6.1% decline in original equipment sales, driven by FPD's 19% decrease, but partially offset by FPD's 12% increase. As a reminder, FPD entered 2021 with an OE backlog down roughly 25% versus the start of last year. Aftermarket sales were relatively resilient, up 3 tenths of a percent, but mixed in composition as FPD's 11% increase was mostly offset by FPD's 1% decline. Turning to margins, our second quarter adjusted gross margin decreased 70 basis points to 31.4%, primarily due to OE sales decline and related underabsorption, including the previously mentioned COVID impacts, partially offset by a 2% mixed shift towards higher margin aftermarket sales. Sequentially, adjusted gross margin increased 100 basis points on a solid 53% incremental margin performance. On a reported basis, gross margin increased 180 basis points to 31%, primarily due to a $23 million decrease in realignment charges as we took significant cost actions in last year's second quarter. Second quarter adjusted SD&A increased $13.9 million to $209 million versus prior year, due largely to foreign exchange movements as well as a return of certain temporary cost benefits realized in 2020, such as the absence of travel that have begun to return. Reported SG&A decreased $18.5 million versus prior year, where realignment charges declined $27 million versus prior year. Second quarter adjusted operating margins of 8.5% increased 40 basis points sequentially, but declined 280 basis points year over year, primarily due to increased under-absorption related to SPD's OE revenue decline. FCD's adjusted operating margin increased 10 basis points year-over-year to 13.3%, driven by revenue growth and tight SG&A cost control, which were partially offset by mixed headwinds. Second quarter reported operating margin increased 330 basis points year-over-year to 8%, including the $57 million reduction of adjusted items. Our second quarter adjusted tax rate at 14% was driven by our income mix globally and favorable resolutions of certain foreign audits in the quarter. The full year adjusted tax rate is expected to normalize in the low 20% range. Turning to cash and liquidity. Our second quarter cash balance of $630 million decreased $29 million sequentially. as solid free cash flow of $14 million was more than offset by our return of $38 million to shareholders in dividends and share repurchases. FlowServe's quarter end liquidity position remained strong at nearly $1.4 billion, including $739 million of capacity available under our undrawn senior credit facility. Turning to working capital, it was a $34 million use of cash in the second quarter, primarily due to accrued liabilities and timing of certain payments, partially offset by modest improvement in accounts receivable and inventory, including our contract assets and liabilities. The performance was much improved from last year's second quarter, when the COVID-related impacts and seasonal inventory build resulted in a use of cash $36 million higher than this quarter's. Taking a look at primary working capital as a percent of sales, we saw a modest 20 basis point sequential decrease to 29.4%, driven primarily by accounts payable, as well as a four-day improvement in DSO versus the first quarter. Despite our backlog increase of $66 million, some progress delays due to COVID, and the proactive purchasing of certain inventory items to mitigate potential supply chain issues, We were pleased that our inventory, including contract assets and liabilities, decreased a modest $4 million sequentially. Working capital remains a top priority for us, and we're confident that the foundation has been laid for further improvement in the second half of the year, as demand-related sales volumes increase results in further reduction of inventory levels. We remain committed to delivering free cash flow conversion in excess of 100% of net income for the second consecutive year. Turning now to our outlook for the remainder of 2021. Based on the combination of our strong first half bookings, driven mostly by shorter cycle aftermarket and MRO activity, and visibility into improving end markets, BlowServe was pleased to increase our adjusted EPS guidance range for the full year to $1.45 to $1.65. In terms of cadence, we expect volumes to increase sequentially in the third quarter and to deliver our typical fourth quarter seasonality. Our adjusted EPS target range continues to exclude expected realignment expenses of approximately $25 million, as well as below-the-line foreign currency effects. and the impact of potential other discrete items which may occur during the year. Beyond adjusted EPS, we now expect less of a revenue decline versus 2020. Our guidance is now for 2021 revenues to be 2 to 4% down compared to last year, versus the prior guidance of down 3 to 5%. In terms of other guidance metrics, our net interest expense remains unchanged at $55 to $60 million, and we modestly lowered our adjusted tax rate guidance to 21% to 23%. From a booking standpoint, we now expect full-year 2021 bookings to increase in excess of 10% year-over-year versus our previous outlook of mid-single-digit growth. Additionally, we believe a majority of this increase will come from our aftermarket and shorter-cycle MRO original equipment products. where the associated revenue may be recognized in 2021. Our expected major cash usages in 2021 remain in line with prior guidance, including dividends and share repurchases of roughly $120 million, capital expenditures in the $70 to $80 million range, and funding our modest remaining real realignment programs. In conclusion, With our solid first half operating performance and improved market outlook, we look forward to continuing the momentum through the second half of 2021 and expect to be well positioned to drive margin expansion and earnings growth in 2022. Let me now return the call to Scott.

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

As a reminder, to ask a question, you'll need to press star 1 on your telephone. To withdraw your question, press the pound key. And your first question comes from the line of John Walsh with Credit Suisse.

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

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

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

Sure. John, you're absolutely right that as we think about that corporate allocation, it's really a component of SG&A in totality and the piece that's not been allocated out to our platform. As we look at the bridge, particularly year over year, FX is certainly a factor and it's actually the largest factor in the mix at between, call it six and seven million dollars of impact in the second quarter. And then the second piece, as you've indicated, is really some austerity measures that were put in place either by necessity or by design. in the second quarter of last year. So travel was obviously halted. We've started to see some of that activity come back, particularly in the second quarter of this year. Some of our discretionary incentive programs did what they were designed to do, which was to pay out significantly below target based on business results in 2020. that is coming back to more like targeted levels in the appropriate relation to our business results as we move forward. So we're starting to see the return of some of those normal business activities. And I'd point out that as you look at where we're at from a margin perspective right now, the long cycle nature of our business means that although we've started to see improvement in bookings, we're really at a trough from a margin perspective. And so as we make our way sequentially through the year and start to see the benefit of those higher sales volumes, we'll start to see improvement in those margin levels.

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

Great. Thank you. I'll pass the baton.

Your next question comes from the line of Dean Dre with RBC Capital Markets.

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

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

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

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

All right, good. Every company has got a different twist. Yeah, that's a really good point. That's pretty standard.

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

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

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

That's really helpful. Thank you.

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

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

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

Very helpful, Scott. And then for a follow-up, maybe an assessment. You talked a little bit about Flosser 2.0 and the prepared remarks, but how it's performing so far as we start, hopefully, this up cycle. I know you said, and I'll say a few years ago, you want to record organic growth on the order of 2% above industry growth. It's hard to sort of measure that. But as we're starting to come out, when you look at some of your longer-term programs, such as strike zone or commercial intensity, how are they faring, and how did that contribute to, for instance, that aftermarket bookings number?

Sure. I think those programs have worked really well. And so commercial intensity is really focused on aftermarket and MRO. And to book a 500-plus number at this quarter is fantastic. And so we're now at pre-pandemic levels for aftermarket and MRO business. I don't think we would be there without that commercial intensity program. And so I think the growth-focused strike zone, commercial intensity, and some of the other things that we've done on our product sides are absolutely helping us return this business to growth. And so I feel really good that we've made that progress. It's institutionalized deep into our organization, and that continues to drive bookings as we go forward. And the other piece to that is the distribution channel hasn't come back as we really thought that that would happen at the beginning of this year. We haven't seen that. But in our discussions with distributors and some of the – the comments that are made publicly from those that do report public financials, you know, I fully expect those distribution bookings to come back in the second half of the year. And that only helps our, you know, that general industries category, but it helps that MRO work as well.

Appreciate it, Scott.

Your next question comes to the line of Nathan Jones with Stifle.

Good morning, everyone.

Morning, Nathan.

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

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

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

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

Great. Thanks for taking my questions.

Your next question comes line of Joe Giordano with Cohen.

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

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

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

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

Perfect. Thanks, guys.

Your next question comes in the line of Josh Pokrzewski with Morgan Stanley.

Hi. Good morning, guys. Morning, Josh. Hey, Josh. just a, I guess, follow up on, on Amy's question from earlier about kind of the order cadence, maybe relative to some of the stuff you're seeing out there. Um, Scott, I guess here you loud and clear on the, on the big projects. Um, I guess some more idea on the distributor restocking. Um, what do you think that, uh, you know, that order of magnitude in terms of what that could look like, just based on, you know, your guys' impression of, of selling versus sell out or, or where inventories versus normal, can go, and is that contemplated in the 950 run rate you guys have talked about?

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

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

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

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

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

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

Thanks. Good morning, everybody.

Hi, Joe.

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

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

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

Sure. No, it is an incredibly important part of what we're doing. And I'd say there's really two main drivers here. But one is the absorption. And so we've got an ongoing program to take roofline out of our total infrastructure as it relates to flow serve. And so we've now completed two of those activities year-to-date 2021, and we will continue to do that. So right now the OE volumes are, we think, at the absolute low. It only comes up from here. And so it was super important to do those exercises in 2019, 20, and year-to-date But what I would say is as we continue, or the other important point here is as we continue our lean activities and as we continue to get more and more productive under the 2.0 transformation, we feel we still have opportunities to consolidate and reduce roofline. And so I really believe that we can continue to do kind of two to three facilities every year and continue to take out that fixed cost within the enterprise. Okay, great. Thank you.

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

Hi, yes, good morning. Thank you for putting me in. Yeah, hey, Andrew. Hey, how are you? Just a question on free cash flow. You know, your seasonal pattern, I think, has changed materially from what it used to be, right? You're now consistently cash generative early in the year. And I was just wondering if industry, you know, as volumes improve, is this something that will carry over, you know, as the industry normalizes, or will you need sort of to commit working capital with the pattern to return to the past? And, you know, just maybe you can also talk about what kind of long-term changes you've made to your processes to enable better cash flow conversion throughout the year. Thank you.

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

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

So obviously in the depths of the downturn in late 2020, there was a lot of just uncertainty and just a lot of our competitors taking price down significantly. And so in order to compete and continue to win work, We did have to follow suit, and I would say that that was the primarily or the biggest impact for CloseServe was in the pump OE business. The valves and the seals and our aftermarket, we've been able to keep our pricing relatively stable. And I'd say where we are today versus a year ago is we're in a much better position. There's still a challenge on the pump OE pricing. I do think that gets better as projects start to move forward. And so as we start to see an uptick in that level of bookings and activity, I do think that we start to move in the positive place on the pricing side. And so while we're not where we want to be, it's substantially better than a year ago, and I think it will be a lot better six months from now than it is even today.

Thanks so much. Cash and bookings show how hard the team has worked. Thanks a lot. So we appreciate that. Thank you.

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