Q3 2021 Flowserve Corp Earnings Call
Yeah.
Okay.
Good day, and thank you for standing by and welcome to the Q3 'twenty 'twenty. One closed third Corporation earnings Conference call. At this time all participants are in a listen only mode. Please be advised that today's call is being recorded.
If you require any further assistance please press.
To hand, the conference over to Jay Whoosh.
<unk> Treasurer and Investor Relations you may begin.
Thank you Justin and good morning, everyone. We appreciate you participating in our conference call today to discuss flow serves third quarter 2021 financial results on the call with me. This morning are Scott Rowe, <unk>, President and Chief Executive Officer, and Amy Schweppes, 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 an audio replay will be available.
Please also 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 October 28, 2021, and may involve risks and uncertainties many of which are being.
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 earnings presentation and are accessible on our website at <unk> Dot com in the Investor Relations section.
I'd now like to turn the call over to Scott Rowe, <unk>, President and Chief Executive Officer for his prepared comments, great. Thanks, Jay and good morning, everyone. Thank you for joining our third quarter earnings call.
There are two key messages that we wanted to cover today first we are confident that flow servers on the path to growth after a dramatic and didn't make driven downturn.
We are optimistic about the future the positive inflection, we're seeing in the cycle and our opportunities through energy transition.
Second we experienced a number of challenges in the third quarter with our supply chain logistics and labor availability.
These problems had an impact on our revenue and profitability in the quarter, but we believe that we will work through the issues and restore our revenue to a more normal conversion rate in the quarters to come.
Let me now move into my prepared remarks.
As I just indicated the third quarter presented a number of challenges, which we continue to navigate including supply chain logistics and labor availability.
Issues were truly global in nature, and it had an impact on pulsar and other global industrial in the quarter.
Or had been largely successful in mitigating these issues in the first half of the year, but the confluence of events and the combined impact of the challenges had an adverse effect on our third quarter results.
I will specifically address the disruption and inflation challenges with the supply chain later in my prepared remarks.
It is important to note that we remain encouraged by the healthy underlying demand that we see across many of our end markets and by the fact that many of the headwinds we experienced in the third quarter.
I would merely timing related.
We expect that our business will return to growth and that's a closer team will work diligently to resolve the issues that we faced in the quarter.
Let me now turn to our results third quarter reported and adjusted EPS were <unk> 38, and 29 cents respectively.
The combination of supply chain logistics, and labor availability shifted approximately $60 million of expected revenue out of the quarter.
Our backlog remains secure and we're confident in our ability to recognize the backlog at a more normal revenue conversion rate in the coming quarters.
Our third quarter bookings of 912 million represented a 13% increase over prior year, continuing this year's trend of strong year over year quarterly growth.
Aftermarket and MRO bookings during the quarter were consistent with first half levels, while larger award activity continues to remain below pre pandemic levels.
Aftermarket orders of $495 million increased 16% and are at pre COVID-19 levels.
The aftermarket business is benefiting from the increased utilization rates of our customers assets.
Being driven by improved mobility, and increasing GDP levels around the globe.
Original equipment bookings increased 9% year over year to $417 million.
Our project or original equipment business continues to lag in the recovery with less than a handful of larger projects awarded in the quarter.
With only two project orders in the $10 million to $20 million range.
Some of the same macro issues around logistics and supply chain are also impacting the progress of these global projects moving towards award.
We remain confident in our pipeline of opportunities and we expect project work to increase from this point forward.
Each of our core end markets delivered year over year growth in the third quarter with oil and gas up 33%, while chemical and power were both up 17%.
Water bookings were also particularly strong up 46% and included a 10 million dollar Desalination Award.
From a regional perspective bookings growth was driven primarily from North America, and the Middle East and Africa.
These markets were up over 30%.
Covid continues to negatively impact full serves and our customers' operations in Asia Pacific, which was the only reason region not returning to growth thus far in 2020 one.
We do expect our overall bookings to recover more towards our first half 2021 quarterly run rate of approximately $915 million in the fourth quarter.
We saw bookings growth in each of the three months during the third quarter and we believe that september's exit rate can restore bookings levels to those of the first half of the year.
Project timing will be the key variable for fourth quarter bookings levels.
We believe full year bookings will grow year over year in the 10% range.
This level of bookings growth positions post serve well for revenue growth and solid financial performance in 2022.
I would now like to return to the operational challenges that we faced in the third quarter.
Approximately $60 million of revenue and $20 million in growth gross profit.
That we had previously expected to recognize in the period was deferred from the third quarter due to the supply chain issues global logistics and labor availability.
We were largely successful in mitigating these types of items during the first half of the year, but as the quarter progressed, we faced significant issues on all three fronts.
Historically challenges like these might affect a few locations in any given period, but in the third quarter. We saw a very large number of our global manufacturing facilities and Trc is impacted by the logistics supply chain and labor issues.
On the supply chain front, we are facing disruption and inflation across the entire value chain. We have done a good job managing our critical vendors for procured items, such as castings forgings machining and large motors.
And we're seeing the benefits from the supplier consolidation and the quality work that was completed in the full serve to Plano transformation.
However in the broad issues.
Pension of lead times across the central components like base materials coatings, small motors consumables and electronics.
Have impacted our ability to deliver product to our customers.
We have now identified and are mitigating these extended lead times, but there is no immediate tax and we expect further disruption in the coming quarters.
To address the accelerating inflation that we saw during third quarter, we have now announced our fourth price increase of the year, which will go into effect at the end of this year.
To continue our efforts to offset the increased cost of purchase items and logistics in the marketplace.
We are in a difficult environment with inflation and cost pressures, but I feel that we've done a nice job balancing enhanced pricing and our pursuit of growth.
With logistics, we're getting impacted in three different ways first our supply chain is predominantly out of Asia and the ability to ship product in that region to Europe in the Americas is now more costly and less predictable than ever before.
It is also difficult to reliably coordinate and schedule product shipments from our factories to our customers and third in some cases, our customers are unwilling or unable to schedule pickup or delivery of our products.
Which impacts the timing of revenue recognition.
While we believe the situation with our customers is getting better we were the most impacted in the latter weeks of the third quarter.
Finally, it is hard to maintain staffing and productivity levels in certain parts of the world in the current environment. For example in China, we're having to hire a significant number of new associates to keep up with demand and to satisfy the emerging local laws.
And Europe labor is especially tight in certain areas while in the Americas. We saw a large COVID-19 course keen rate during delta's rise and it is also a very tight labor market.
We are pleased that the heightened COVID-19 cases and related core teams. We saw in the third quarter across our business have consistently declined through October we're encouraged by the continuing downward trend.
We will of course continue to focus on the safety of our associates as we have been since the start of the pandemic.
We are actively working through each of these disruptions we expect it will take a few quarters for us to adjusted extended supplier lead times.
And in logistics and the issues with labor availability before we return to the more normal operating model.
Additionally, we have not seen nor do we expect an increase in cancellations from our backlog. So our revenues are there for us to deliver in the coming quarters.
Following our third quarter results and with the assumption that these issues will impact closer to in the fourth quarter and likely into 2022, we adjusted our 2021 full year guidance metrics yesterday.
As we indicated in yesterday's press release.
Our revised adjusted EPS range is now $1 40 to $1 45.
I'll now turn the call over to Amy to cover our financial results in greater detail.
Thanks, Scott and good morning, everyone looking at the third quarter financial results in greater detail, our reported EPS of <unk> 38, and exceeded our adjusted EPS at 29.
$16 $6 million discrete tax adjustment from the reversal of certain deferred tax liability.
Partially offsetting the 13th ethane on taxes, our adjusted EPS also slated for sensitive items, including realignment expenses.
Thank you.
And certain costs incurred in our debt refinancing.
During the third quarter, we took advantage of the favorable debt markets to solidify our liquidity and financial flexibility.
By pre funding upcoming debt maturity.
We amended and restated senior credit facility by extending the maturity of our revolving credit facility by two years and enhancing our financial flexibility we have on it.
As well as lowering the ongoing commitment and including.
Including a sustainability linked to option to enable further cost reductions as we progress our ESG objectives.
In addition to the revolver. We also obtained a $300 million fully drawn term loan which included participation from our minority owned depository institution.
And most of the syndicate banks in the revolver.
We sincerely appreciate the support of our historic any banking partners and other facility and look forward to working closely with them in the years ahead.
In September we also accessed the debt capital markets and issued $500 million and two 8% 10 year senior notes.
We value the confidence of investors in this offering as well.
In October we use all the proceeds from the term loan and senior notes. In addition to some excess cash together totaling $842 million to fully redeem our senior notes with maturity in 2022 and 2023.
Now I'd like to return to our third quarter financial results.
As Scott mentioned, the third quarter was impacted by supply chain logistics and labor headwinds.
$60 million in expected revenue out of the quarter.
She was primarily occurred late in the third quarter.
Revenue decreased six 3% to $866 million largely due to the deferred revenue I just mentioned.
We had an 11% decline in original equipment or OE sales driven by F. P. D 20 per cent decrease.
Partially offset by S T D 2% increase.
Beyond the challenges in the third quarter FTE continues to be impacted by 2021, beginning backlog, which was down roughly 25% versus the start of 2020.
Aftermarket sales remained relatively resilient in total down roughly 1%, whereas C D, 12% increase with best buy SPD <unk>, 3% decline.
Turning to margins.
Third quarter adjusted gross margin decreased to 190 basis points to 29, 6%, primarily due to the sales decline and the related under absorption, particularly in our engineered to order sites in both segments.
Yeah. They are previously mentioned disruptive impact as well as higher logistics costs, which increased 25% year over year.
These headwinds were partially offset by a 3% mix shift towards higher margin aftermarket sales.
On a reported basis the gross margin decrease of 160 basis points to 29, 3% was driven by the factors previously mentioned, partially mitigated by the $3 million decrease in realignment charges versus prior year.
Third quarter, adjusted SG&A increased $7 $4 million to $200 million versus prior year, primarily due to a $3 million increase in expense related to our incurred but not reported potential reserves.
Increased R&D spending and returning some travel costs, which were a temporary benefit in 2020 as well as headwinds from foreign exchange.
Reported SG&A was flat with prior period and these increases were offset by a $7 million decrease in adjusted items and disciplined cost control offset the return of some of last year's temporary cost benefit.
Third quarter, adjusted operating margins of 7% decreased 390 basis points year over year at the FTE adjusted operating margin, primarily due to increased under absorption related to its 20% revenue decline.
S. T E. Adjusted operating margin decreased to 170 basis points year over year to 10, 5% due to sales mix and slightly higher SG&A as a percent of sales.
We expect the sales volumes normalize that margins will improve and to that point had closer to $60 million revenue deferral. Our adjusted operating margins would have been flat to modestly up on a sequential basis.
Third quarter reported operating margin decreased 280 basis points year over year to six 6%.
The previously discussed challenges more than offset that $10 million reduction of adjusted items.
Our third quarter adjusted tax rate of 15, 2% and it's driven by our income mix globally and favorable resolution of certain foreign audits in the quarter.
Full year adjusted tax rate is expected to normalize in the 20% range.
Turning to cash and liquidity.
Third quarter cash balance at one $5 billion, reflecting the debt refinancing discussed earlier as well as the solid cash flow performance in the quarter.
Our net debt position of $652 million at the end of the third quarter has declined by over $300 million in the last three years.
We believe a bright spot in our third quarter financial results is our continued progress on cash flow.
On a year to date basis through the third quarter.
Free cash flow of $151 million is up nearly $37 million versus the prior year, while free cash flow of $117 million has increased 73%.
$49 million over the prior year.
In the third quarter, we delivered $78 million or approximately 67% of our year to date free cash flow totaled.
Third quarter performance is up versus the comparable period in 2020, despite voluntary funding of a $20 million pension contribution during the quarter compared to no funding a year ago.
We are pleased with our improved cash flow performance year to date and they are typically seasonally strong fourth quarter ahead, we are confident in our ability to stay on pace to deliver a free cash flow conversion of over 100% of our adjusted net income once again in 2021.
Working capital what the cash endorsed at $56 million in the third quarter, and a $47 million increased versus last year.
Accrued liabilities prepaid expense and continued improvements in our accounts receivable process were the major contributors this quarter.
As a percentage of sales primary working capital saw a modest 40 basis point sequential increase to 29, 8% due primarily to the market disruptions in the quarter.
Both DSO and inventory turns were roughly flat sequentially.
I would also like to highlight our disciplined inventory management for the for the third consecutive quarter, our combined balance of inventory and contract assets and liabilities decreased while backlog continued to increase and despite holding elevated working process and finished goods inventory at quarter end.
Due to some logistics challenges.
Since year end 2020 backlog has increased to $115 million, while inventory and contract assets and liabilities have declined $16 million.
Major you think in the third quarter, including dividends and Capex at $26 million and 11 million dollar tree Secondly, as I. Just mentioned, we also contributed $20 million to our U S cash balance pension plan keeps us largely fully funded.
In the fourth quarter major youth is expected to include the completed retirement of the 2022 and 2023 senior notes the $26 million of October dividend and a higher level of Capex.
Turning now to our outlook for the remainder of 2021.
Some of the supply chain and logistics challenges better Roes and accelerated late in the quarter its impact on our third quarter earnings and the expectation that these conditions will persist.
Hello, Sir have revised our full year 2021 revenue and EPS guidance ranges.
We now expect our full year revenue decline of three and a half to four 5% and reported an adjusted full year EPS of $1 five to $1 10, and a dollar for each $1 45, respectively.
To briefly cover our thought process, we expect our revenues and income that were deferred out of the third quarter to be largely realized in the fourth quarter.
However, we expect the challenges of the third quarter due to continued industry wide for the next few quarters. So we are assuming the fourth quarter has a similar deferred revenue impact to what we just experienced.
It's coupled with the impact of the strengthening dollar on our non U S denominated sales, particularly the euro resulted in us lowering our expectations for full year 2021 revenue.
We do expect that the fourth quarter will have the traditional closer fourth quarter seasonality with strong revenue conversion. However, we do not expect that revenue and the associated profit will be fully caught up at year end.
Our adjusted EPS range continues to exclude the expected realignment expenses as well as below the line foreign currency effects and the impact of other potential discrete items, which may occur during the year.
It's a premium and fees incurred to retire than now.
In terms of other guidance metrics, our net interest expense remains unchanged at $55 million to $60 million and we modestly lowered our full year ago adjusted tax rate guidance to approximately 20%.
From a bookings standpoint, we now expect full year 2021 bookings to increase in the 10% range year over year.
Additionally, we continue to expect the majority of this increase will come from our aftermarket and shorter cycle MRO original equipment.
The major categories of our full year cash cash usages include the October debt retirement dividends and share repurchases of roughly $120 million.
Capital expenditures in it.
$5 million range, the third quarter's pension contribution and the funding of our now modest realignment program.
In conclusion, while our third quarter was impacted by supply chain logistics and labor headwinds we view these primarily as transitory.
Transport, our traditional markets whats happening there is an increasing interest in our energy transition offerings, and we continue to build momentum in our operational and cash flow progress.
With a solid and growing backlog and expected progress by the broader industry and managing the supply chain and logistics headwinds, we believe that flow serve us well positioned to deliver earnings growth in 2022.
We now return the call.
Thank you Amy before addressing our outlook for the remainder of the year and some early thoughts on 2022.
Let me first provide an update on our strategic initiatives.
While current conditions are increasingly favorable for our traditional energy markets.
We're taking steps to best position the company for the energy transition that is already underway and which presents a significant long term opportunity for closer to our shareholders and all stakeholders around the world.
To support our efforts we have increased our strategic focus on three major themes de carbonization, digitization and diversification to accelerate our growth in 2022 and beyond.
We continue to identify significant energy transition opportunities in applications, where we have been supporting our customers for decades as.
As we focus on lower carbon energy production, we are investing in technology to advance our customers' aspirations, including additional capabilities within carbon capture hydrogen energy storage.
We are still in the early innings of tapping into this growing market and our third quarter bookings included over $25 million of energy transition work, including biodiesel conversions solar power projects in energy efficiency upgrades.
Our project funnel for energy transition continues to grow demonstrating we have the flow control products and expertise to support our customers today and through their energy transition journey.
I'd like to highlight a few examples of our third quarter bookings success stories.
Wholesale was selected to provide pumps and seals were sustainable aviation fuel project in the Netherlands.
Facility will produce sustainable aviation fuel that when compared to fossil jet fuel has the potential to cut lifecycle emissions from aviation by up to 80%.
Additionally, we will remain active on the facility for years to come ensuring the lowest total cost of ownership with the inclusion of flu serves lifecycle advantage aftermarket solutions.
Our pumps and seals were also chosen recently for our biodiesel conversion project in the United States.
Closer of helped compress the engineering and approval time from a normal 12 week 12 month cycle to seven months supporting it earlier plant startup and delivering a faster payback.
<unk> is expected to reduce C O two emissions from diesel production by up to 600000 tons per year.
In addition, our vacuum pump technology was selected to support a leading provider of thin film technology for the production of solar power panels.
We will provide equipment for new facilities in the U S and in India, reducing the overall power consumption maintenance downtime in the floor space required.
Finally, let me update you on the progress of Red Raven, our our Iot offering launched earlier, this year, which instruments pumps valves and seals systems to provide the capability to assist our customers with a data driven approach.
How to improve their operations increased asset uptime and reduce associated energy emissions.
We continue to expand the red Raven instrumentation across product portfolio in the quarter and further increase access for our customers while developing the distribution channel.
We are currently working with over 40 customers and have connected nearly 5000 assets.
While we are still relatively early in the rollout customer interest continues to increase.
Turning now to our outlook for the remainder of the year and our positioning as we think about 2022.
With bookings continue to improve in October we are confident in the market outlook as we close out the fourth quarter and planning for 2022.
As I indicated earlier, we expect fourth quarter bookings to be roughly $950 million, depending on the level of project activity.
Achieving this level, our 2021 bookings would deliver a 10% year over year growth rate.
Based on current market conditions, we also expect year over year bookings growth to continue in 2022 based on our discussions with our customers EPC backlogs in our project funnel.
We believe that the lessening impact of the pandemic combined with increased energy demand growing de carbonization and energy transition opportunity in global economic growth create a compelling view of our markets.
Additionally, with increased utilization, coupled with energy prices that are well above pre pandemic levels. We expect that our customers will continue their aftermarket and MRO spending as well as return to their capacity expansion plans across our served markets.
Project funnel remains well above prior year levels, providing confidence that while the timing of the return of these larger project remains uncertain. We expect that many will ultimately move forward in 2022.
All of this gives us increased confidence in the flow control markets driving bookings growth throughout 2022.
Additionally, we believe that our added focus on de Carbonization, Digitization and diversification will only enhance our growth outlook.
Looking both near and longer term energy transition investment will provide strong opportunities for flip serve while we continue to support our customers traditional applications. We believe we are well positioned to support our customers' energy transition initiatives.
Operationally I'm confident that we have the team and the tools to work through the third quarter challenges.
Closer to point out when you provided the visibility and business processes to address these issues and our teams are currently working to resolve and mitigate issues that arose in the third quarter.
Longer term, we expect the opportunities from our served end markets combined with our improved operational execution and an embedded continuous improvement culture will enable closer to deliver on the longer term targets. We introduced during our last analyst day.
In closing, we believe that with the expected return to growth and continued execution improvements closer will be well positioned to deliver stronger incremental margins and overall financial results. We believe in the company's long term ability to achieve our original targets.
Including operating margins in the 15% to 17% range ROIC of 15% to 20% and to continue free cash flow conversion in excess of a 100%, which we've already demonstrated.
Our focus remains on supporting our customers.
Execution, and capitalizing unimproved markets to drive long term value for our shareholders and our stakeholders.
Operator, this concludes our prepared remarks, and we'd now like to open the call to questions.
And thank you as a reminder, or ask a question you will need to press star one on your telephone So Joe Your question press the pound key please standby, we compile the Q&A roster and once again that is star one.
Our first question comes from Deane Dray from RBC capital markets.
Thank you and good morning, everyone.
Hey, Deane good morning.
Just I appreciate all the specifics here.
And maybe we start with a line of sight on that $60 million revenue push and that's pretty consistent we've heard from a number of your peers on just the logistics of not being able to get those products out the door.
But I'm curious if you're hearing a bit more on the assumption for the fourth quarter kind of a repeat is that more of a placeholder or have you really done kind of a bottom up analysis of what you can or may not be able to ship in the fourth quarter.
Sure I'll start and Scott can add some color I think to start with one of the one of the frustrating things about the challenge that we experienced in the third quarter. It is it did occur quite late.
And it wasn't linked with our with our major components and so there was an element.
That was it was very late occurring which makes it somewhat difficult to plan in the future. What we do have really good line of sight on is that the $60 million of deferred revenue has largely shifts or we'll ship them in.
In the fourth quarter and so as we were looking at fourth quarter revenue protection. We thought it was prudent at this point to assume that we were going to see a similar deferral.
Out of the fourth quarter as well just based on <unk>.
General congestion in the fourth quarter and in our line of sight to be continued challenges.
Yeah, I'll just add on that to Andy's point a lot of this is built throughout the third quarter and it really came to roost in August and late September.
We're still wrestling through this we don't think we're where we know we're not out of the woods. We know that there are still challenges ahead, and we put guidance out there in the fourth quarter that to the best of the.
At.
That site in the viewing that we have we are working through all of the resolution actions right now and you know every week that goes by we get more and more certainty on what we can do in Q4 and 2022.
Got it appreciate that color and then look one of the bright spots in the quarter is on free cash flow and I. Appreciate the details being provided and Amy I don't know if you intentionally did this but you said you saw.
Once again, we will be above a 100% free cash flow conversion like its routine because a couple of years ago. It was not routine at flow serve that was an area that from a quality of earnings needed to improve.
The improvement is really coming through now so look a lot of heavy lifting was done over the past couple of years, but Amy from your perspective, what are the structural changes that have made this hopefully a more permanent.
Conversion of at least 100% working capital efficiency asset utilization, just kind of take us through it what has made this.
From your perspective.
It should be more a routine that we should see from flow surf.
And I'm really proud of the efforts.
Yeah.
Both platforms and functions have put into improving our working capital performance and that has been really key them in in the improvement in free cash flow conversion and so it's really started.
With the cash collections process with our invoicing and collections process centralizing that I'm getting getting insight into and into performance, where we needed to focus our efforts using standard processes and systems.
And to do that and this year and last year that focus has really been on on inventory management and that's not been without challenges, but I think that this quarter is an excellent example.
Work that the team and.
The team has done in trying to manage and both are growing backlog.
And inventory management in the process I will tell you given the deferral of revenue that we had at the end of the quarter and if you would've told me that inventories could have improved sequentially I would've been extremely surprised but I think it's just.
An indication of the efforts that the team has put into that and then the process around around planning and from that from a demand standpoint, and what that means on the shop floor.
Great to hear thank you.
Thank you.
And our next question comes from Damian Karas from UBS. Your line is now open.
Hi, good morning, everyone.
Good morning.
Unfortunate to see some of the supply chain headwinds hitting you guys, but.
Good to see on the on the flip side. The bookings continue to look good. There I was wondering if you could maybe give us some additional color on on how the up the book.
Bookings are trending through October and just curious thinking.
Thinking about the 950 million how much project.
Project activity.
Uh huh.
If any at all kind of do you need to get there.
Sure. So you're right now we feel good about the 950 <unk> it.
Is it dependent on projects coming through in getting booked at the end of the year, we feel really confident on the aftermarket run rate in our MRO spending and so that's been consistent all year, thus far our aftermarket number in the Q3 was solid and its right at that kind of $500 million level, which is that pre pandemic level and so we feel.
Really good on aftermarket and MRO, continuing and typically at the end of the year, we see a little bit of an uptick from Q3 to Q4 there.
So I think that will help as well and so it all comes down on these projects get booked and.
That operators have the confidence to move forward with us and you know what I would say as you know normally I would be incredibly confident with this but as you know lead times are changing and as prices continue to get a just I think some of our operators are hesitant to pull the trigger on the very large projects.
So we've got a few planned in our numbers, but what I'd say is we've risk adjusted that right now and we believe more of the larger projects will happen in 2022, and so it's really just a matter of kind of this $5 million to $10 million range of projects coming through at the end of the year. We're currently optimistic on that situation we know.
We know they have to do this work they're committed to it. It's just a matter of will they pull the trigger by the end of the year Award rollover into 2022.
Okay got it.
And I guess thinking about all the moving pieces now with a you know a decent chunk of deferred sales, which are going to show up in 2022 now and then.
The price cost dynamics, how should we be thinking about incremental margins. When you returned to growth next year.
Sure. So with respect to margins, we do think that volume is key in expanding those margins as we make our way through the fourth quarter and into 2022.
That makes sense. He actually currently having are in our backlog it's favorable to margins gross margin drivers. If you look at the mix between between aftermarket and reaching all equipment, what we'd like to see some strength in those OE bookings and so at our at our large engineered to order.
In particular, we get those volume levels to cover to cover some of our absorptions.
Absorption.
And and and and obviously and that will be really helpful. In expanding margins. The one thing that I would say is that our SG&A performance has been had been solid so as we see those gross margins expand and we're going to see a lot of backdrop for that drop to the operating income line item line item as well.
And given the work that's been done with respect to SG&A.
Okay, great. Thanks for taking my questions.
Okay.
Thank you.
And our next question comes from Andy Kaplowitz from Citigroup. Your line is now open.
Good morning, everyone.
Hey, Andrew.
Scott, obviously, we have what amounts to an energy crisis in several parts of the world as you speak with your customers do you think they can still defer capex in 'twenty two as they have in 'twenty. One and then as you look at your major end markets can you give us some more color into where you expect to see the most bookings growth in 'twenty two is it chemicals could you.
See a revival of LNG me more traditional power related work anymore color would be helpful.
Sure Yeah and to your first point I don't think operators can hold capital spending any longer and so we feel pretty confident on the project spending in 2022, it's a little shocking that it hasn't happened already but in talking to them. We know theres a lot of a lot of projects on the books, there's expansions and theirs.
New projects as well and so I really do believe that 2022 is the year that kind of unlocked that as we think about regions. The middle East is certainly a big region that will spend lots of money in.
And we know that there's major projects on the books that we're well positioned for we also know that Asia Pacific will move forward with the additional spending in infrastructure and so we're excited about India opposite India got hit significantly in the second quarter and I think as they're kind of re emerging from the Covid crisis that they had their <unk>.
Their project plans and the investment schedule and then there's also work here in the United States and so there's still infrastructure, that's gotta get built out.
And then when we look at in markets. The end markets that we really like would be LNG would be one there were no no major project awards for us in the third quarter, but there could potentially be some in the fourth quarter, but also as we know for sure things will go forward in 2022, and then on the chemical side, we have seen it up.
Kick in growth, there and our products that support specialty chemicals like vacuum and some of our other smaller pumps and valves have done well this year and we expect that to continue to go as we go forward on the refining side I do think there'll be investment more on that just kind of the general upgrades and just making sure that the assets run as well as possible.
I don't expect major capital will be deployed in new refineries or big expansions with the exception of China and some parts of Asia, but I think overall with the just the power situation, where oil prices are where natural gas prices are countries customers Aqua figures are all looking for.
Thing two to invest.
<unk> invested and move forward to solve some of the challenges that the world is seeing right now.
Very helpful color and then can you tell us what the ultimate impact of price versus cost ended up being Q3, I know you said last quarter that you announced a price increase at the beginning of Q3, but you also had said that you wouldnt see a benefit until early 'twenty. Two you just announced another price increase you know for the end of the year here. So ultimately when do you think price versus cost.
Could turn positive for floaters.
Yeah, It's a really good question, indeed, I'd say that there's a lag when we announced to when we can realize it's anywhere between a month or two.
Pending our contracts and how we how aggressive we can get it into our customers, but so right now I'd say Q2 was slightly negative we were certainly negative in Q3, we saw significant inflation throughout the quarter.
In many of our commodities and components now we have announced the first price increase which will go into effect at the end of the year that would be a pretty significant increase and we expect that to come through January one of 2022, and so I think we're doing a reasonable job, but we're probably again two months behind.
And maybe kind of eight weeks to 10 weeks behind.
And so we'll catch up.
As the as the year finishes out and into 2022. The other point that I do want to make is that a large percentage of our business is the engineered pumps and the engineered valves and the pricing on that truly is a cost plus model and so we build up the costing as we see it and we can typically get solid quotation from.
Our vendors and suppliers that they'll hold in a contract and so on that side of the business, we're actually doing well.
We're tracking our margins and our expected margin and we're confident that we've got margin improvement in the backlog as we think about 2022. So again overall I think we've done a nice job on price cost, but it's just an incredibly challenging environment right now and we're seeing some of the inflation across some of the things that we're trying.
But it's just it's tremendous I get what you're seeing 50 70 per cent increases across commodities that you would never expect this type of inflation on it and so we've got to stay diligent will continue to work that but overall I feel like we're in a reasonably good position on price cost.
Appreciate it Scott.
Yeah.
Thank you and our next question comes from Josh Bakugan Penske.
Of Morgan Stanley. Your line is now open.
Hey, good morning, guys.
Hey, Josh.
It's got so one thing that we've kind of talked about over the last few quarters.
That has been kind of a surprising thorn in your side is the distributor inventory I would imagine in Peru, what what has historically been kind of the IPD business where.
That was fairly well when you were anticipating at some point had been for restock.
Maybe now is not being exact time because of the supply chain issues, but you know what what progress if any where are you in those customers able to make on that replenishment.
Sure.
Sure Yeah distributions, a really important part of our channel to market and it's exceptionally president in North America, and so we talked to our pump distributors, all the time and our valve distributors and what I'd say is their bookings have certainly increased in Q2 and Q3 and so we were seeing that restocking has.
Turning now.
Can see it in our numbers that come through on the MRO and aftermarket side and the general industry category that we break out and so we feel good about what's happening over the last two quarters and we're confident that there's more to come when we look at some of our distributor inventory levels, they're still not at that pre pandemic level and so we know that theyre going to continue to move there.
Our inventory levels up to support the overall business. So I think that's a certainly a bright spot for us and it's come through and you know it shows up again and that aftermarket MRO and in the general industries bucket.
We expect more more growth to come as we think about fourth quarter and into 2022.
Got it that's helpful and then.
Just on 2022, I mean, obviously the macro environment has been way different than you guys would have expected a few years ago. When he put out the margin targets, but project activity seems like it's been kind of the the biggest surprise.
Yes.
What I'm struggling with there and maybe you can sort of help rank order or the opportunities that remain in the project activity doesn't seem like it's super high margin and yet it's a quarter, we had a bit of an impact on you know where you guys would have seen those margins come out but can you help square up maybe like where you see kind of the biggest opportunities are gaps.
Relative to where you thought you might have been a few years ago, yes.
Yeah, Let me I'll start and then I can let Andy answer that but it really is what we wanted strong aftermarket and MRO growth, which what we're seeing this year that does have a positive margin mix and so that's now going to start to come through the system and then on top of that we want a healthy project business that will be at a little bit lower margins, but.
What that gives us a significant absorption in our sites and we're missing that right now and so we're having to deal with the under absorption and it's coming through the P&L and it's definitely has a headwind in the margin as we can grow that side of the business, we feel a lot better about our ability to get the absorption in a much better place and start to see.
Margins come up right.
He's got more details on that yeah, and I would say you know Scott Scott on systematically here I think from a from a margin perspective, we believe that we're really in the trough of the downturn here and it's and it's driven by by two things.
And mitigated by one and so the two things that are that are impacting us right now on the OE side are really the fact that the volume is at suboptimal levels and if it does it does impact us in terms of in terms of our margin performance and the second piece is that the is that the OE.
Sales that we're experiencing right now were booked at the height of the downturn that we can think about.
That that pricing environment. It was very competitive as we made our way through the second third and fourth quarter of 2020, and and that is and that is we are feeling that in our OE margins today.
And that the mitigation of that is really the fact that the mix. It's Scott has indicated it's been quite quite favorable for us and for us and in 2021 in terms of both our bookings and our scale.
So as the.
As it.
But again it gets back to even some kind of normalized levels away from the away from the 18% to 20% down and he built that backlog and as S. E mail in in the fourth quarter and into 2022, we are going to see margin expansion.
Got it that's helpful. Thanks, Jim Good luck.
Thank you.
And thank you and our next question comes from Joe Giordano from Cowen. Your line is now open.
Hey, guys good morning.
Hey, Joe.
And so I know you.
You mentioned earlier, Scott that cancellations haven't happened yet so.
So you feel comfortable there.
The longer that the supply chain things linger like what gives you confidence that that's not just like the next thing that's going to happen is the logical extension of all of these problems that people are just like you know what these projects does have to go out longer.
Yeah, No. We're we typically don't see a lot of cancellations in our backlog and the delays that we're experiencing are our weeks not months and so I really don't expect cancellation of backlog and so I'm fairly confident on that I'd say, probably the bigger concern that does lead times push out and costing gets higher than <unk>.
Customers are going to re look the project environment to make sure that it's a financially viable project.
I think that's kind of the risk.
We haven't heard that from a lot of customers yet, but we do think that there's some concerns there that that that's a potential that could happen there are risks, but cancellations in our backlog that I really don't see happening.
And then.
You know as far as the energy transition and stuff.
So a nice.
For Medicare to be its growing for you guys, but it's still it's certainly not the perception of the company like what's your appetite.
To accelerate that in like a bold way maybe through some like an acquisition you have a you have the balance sheet to do some stuff. So how fast are you willing to move on that to make it like something that people really focus on.
Yeah.
It's a really good point and it is something we're very focused on and so this year, we're already at kind of $125 million to $150 million of bookings hopefully we can finish here about $200 million of bookings in this space and so we're committed to this and you know what I would say is our internal employees are really excited about this direction and being a part.
It is something that can really solve some major issues around the globe and then we're seeing from our customers that we've got a full control operating that that really does fit in some of the things that they're doing and so we spotlighted a couple of awards this quarter around the biodiesel conversion so to say.
Annual aviation fuels, a solar power and so what we've done now is kind of retooled all of our internal product development and R&D to make sure that we can have an offering in our flow control solution in this type of atmosphere.
So all of our R&D and new product development is now focused on either diversification de carbonization or on the digital side and we've been doing that now for over a year until we kind of pivoted all of that effort there and we stood up a designated teams now to support our business development activities are.
The energy transition and so you know I I.
I think I'm not going to say, we're all in on this but we are pretty committed we're confident that the outlook is it is a significant growth engine for us and will grow faster than the current markets that we're participating in and so we're going to continue to put the resources and the effort there that we can capture.
Big share of the spending in the flow control space associated with the energy transition.
And I'd like to touch on that for them from an acquisition standpoint, I think the first question that we ask as we look at any any sort of opportunity. It does it align with our strategic focus areas in there add Scott to finding in his prepared remarks around de carbonization digitalization and diversification.
So it doesn't give us a bigger and bigger piece of that pie going going forward and then obviously as we move on from there we have to ensure that it lines up and it's financially attractive and dry drive shareholder return.
So I think that the strategic question and we feel that that can be part of the answer for us going forward.
But but it needs to align closely with that strategy and drive the financial results that we want to see.
Okay.
Yeah.
And thank you and our next question comes from Joe Ritchie from Goldman Sachs. Your line is now open.
Thank you good morning, everyone.
The border.
So I wonder if maybe just talk about the <unk> guide for.
Sure just a second I when I kind of try to put some numbers into my model, maybe I'm doing this wrong it seem to imply like pretty good sequential margin improvement in both of the segments and so just trying to understand what's kind of driving the sequential margin improvement I know volumes are going to be higher in the fourth quarter.
But any color you can give on that and specifically for each of the segments that would be great.
Sure. So yeah. So a couple of things one yeah. We you've heard me now probably say three or four times over the course of the call that we do think that volume is it is a pretty important element in us improving our.
Our margin performance in it and it's certainly the loss of that $60 million certainly had an impact on our margin performance.
In the third in the third quarter. So a fair amount of that is driven and it's driven by that by that volume increase the other element that I would say that that comes into play at this mix issue that we continue to talk about so as we look at the backlog and it is focused on on aftermarket and.
That resiliency in the aftermarket.
Looking that is driving in both a bar in both of our segments.
Some of that some of the volume expansion at quarter on quarter.
Got it I mean is it fair to say that you know sequentially, you know incremental margins should be like 35% to 40% from <unk>.
We see although we're not guiding specifically on that we're seeing margins expand quarter on quarter and absolutely.
Okay, and then maybe just one quick follow up on and I'm, assuming your customers clearly understand kind of the environment that we're in but I'm curious on some of these deferred shipments are there any penalties associated with those shipments are you now just given the environment that we're in customers or kind of understand the backdrop.
Yeah sure the penalties are called liquidated damages.
I'd say as you know.
Right now with the current environment, our customers have been somewhat sympathetic to Oh jeez. There are times when we've had some significant issue within our facility that's delayed something and those will come through the system, we had a little bit of that in the quarter, but I'd say that the disruption that we're seeing right now primarily is not <unk>.
With the liquidated damages.
Most of the delays really were on our smaller project or product rather than some of the bigger projects that would have the formal liquidated damage provisions and so a lot of the delays that we saw were in our valve business on just kind of one off a few off valves in the MRO side, we saw delays in our aftermarket business and ability to get services in <unk>.
And typically that wouldn't carry liquidated damages.
Saw it in our seal business as well that typically wouldn't carry liquidated damages and so.
So a lot of this disruption has just been that kind of a broader set of our more basic type of products rather than the projects that do carry that but it is a it's a good question. The LDS are part of the big projects, but I feel confident in our ability to mitigate that just with conversations and open dialogue with what we're seeing with.
The supply chain and other things.
Got it that's helpful. Thank you.
Thank you.
And our next question comes from John Walsh from Credit Suisse. Your line is now open.
Hi, good morning.
Good morning, John.
Right.
Maybe just a first question going back to kind of what it looks like as we go into 2022, if you hit your orders kind of guidance here as we go through the end of this calendar year does that alone give you kind of enough visibility that we won't have any kind of.
Under absorption issues next year or do we need to see kind of the orders follow through into Q1, and Q2 to kind of get past any concerns that there could be under absorption on the larger project business or the engineered project business.
Yeah. So.
I'll start there I think we still need to see some uptick in that original equipment business.
In both the fourth quarter and ended the first and second quarter of next year much of that work and can start it's generally under person under percentage of completion.
Accounting, so we start to we start to be able to absorb some of those costs I'm pretty pretty quickly as those as those orders come in and despite the fact that we may not shipping them for some time in the future. So the fourth quarter is important but the first half of next year will be will be important as well.
And ultimately the mix of the business. Obviously is understood is being some of the driver of that we want to continue to see the strength in aftermarket and MRO, but we wanted to see that supplemented them with some of this project business coming back into play.
The other thing I'd just add is we're not done with our refined the optimization and so we continue to look at that and.
So and apply some of the work that we did in closer to Plano, what we're seeing is our ability to enhance productivity, which in turn increases our capacity and so as our capacity increases at the sites that are our preferred sites for manufacturing pumps valves and seals. Then we can start to look at further rationalization.
And so we've been doing kind of anywhere from four to two consolidations a year, we'll continue that pace into the future, which which will additionally help on the absorption side.
Great. Thank you for that and then you know almost maybe as a as a look back.
I guess you guys have been active on the governance side. This year I can go back to a an 8-K earlier this year when you kind of got rid of the supermajority approval on some things.
<unk> also put out your ESG report just you know.
Seems to be pretty active on the governance side could you just kind of help us.
Understand kind of the catalyst behind some of those things.
Yeah, absolutely no I appreciate you pointing that out we have a slide in the presentation and so I encourage everyone listening to go to our slide and it looked at some of the things that we're doing on ESG progress.
This is something that's very important to me, it's important to our board into our shareholders and so we're very focused on this and get it to your point, we've made great progress in our governance structure over since really since I've been here and we've done that with our board succession, we've done it with tightening up some of the different things around our governance and making it more normal or.
More kind of where we would want within the governance framework.
Additionally, on the ESG side, we put out what was our first ever.
S G.
Report this year traditionally we had called that the sustainability report is focused really on the environmental and sustainability side and so in 2022 really it was really last month, we put it out was the first ESG report. So again I'd encourage you to go to our website, where you can find that.
We talked about there are progress on reducing carbon emissions, we talked about what we've been doing on the social side with our employees.
Which really is around safety, it's around diversity equity and inclusion and.
And it's really taking in the community aspect of pulsar cares and making sure that we make a positive impression in the communities, where we live and work and then on the government side, we've already talked about some of the things that we've moved forward with but this is something that's in the forefront of all of our discussions with our board and we want to make sure that folks are truly is doing its part with.
ESG and having a positive impact in the communities, where we live and work.
Great. Thank you appreciate you taking the questions.
Okay.
Thank you.
And our next question comes from Andrew <unk> from Bank of America. Your line is now open.
Yes, I guess good afternoon, thank you for fitting room.
Right.
I guess, it's still morning, where you guys are so.
Alright.
Moreover, philosophical question right. So how does this.
Sort of tug of war works between you and your customers right because they're facing a labor shortages on certain shipments and you guys are sort of saying, they're not going to be cancellations I totally appreciate it.
You guys are clearly for you. There's this tug of war between absorbing volumes I'm absorbing fixed costs and being aggressive on pricing. So in terms of contract structure and pricing dynamic could you give us. Some inside you know how do you find a middle ground with your customers right because they are.
Clearly want to make sure you're healthy and able to.
To ship this stuff right.
We'll go back to 2020 with the Covid pandemic that hit US dramatically in February March and April the business went down about 20% and we've been you know the good news is we have a long list of historic customers that we have partnerships with I have steering committee in strategic discussions with a lot of our top cut.
And they truly our partners and so I think that's probably the most important thing is that they they know and recognize the value that puts a brings to their installations of their operations into their future and we recognize the importance of them and everything that we do here at full service. So I think it starts with that but the other thing I'd want.
I played out it's like this is this is happening to everybody in the space on a competitive standpoint, and so we're not alone and we're all experiencing the same pressures, but it is an incredibly dynamic environment right. So COVID-19 last year and now.
Are you still facing issues this year and now we're seeing that the entire supply chain shock as all companies around the world are starting to move back in reemerged from from this recession and push forward is it's causing this massive spike in and a massive disruption across the supply chain and so are our customers are simple.
We've got to continue an open dialogue with them, we have to be transparent with what we're doing and I'd say, we're doing a much better job of that at closer than we ever have and so we'll continue to have those open dialog will continue to be transparent with the issues that we're facing.
And at the end of the day, we're going to make sure that we do the right things that support the long term growth for closer with it with the partnership and then making sure that we can drive shareholder value over the long run.
Thank you and just a follow up question I don't know if you've heard anything about it but you know we've been beating that.
Energy prices in China is making them reassess some sort of lower and more power consuming industries.
Industries.
Does that.
Impact.
How does it impact I guess the flow industry right, because a lot of sort of more generic product coming out of China, a lot of casting a portion of that coming out of there.
Is there any impact from the policy have you had any conversations with your suppliers and I'm going to impact the competitive dynamic. Thank you.
Yeah, we haven't seen any significant impact, we're staying close with our suppliers there and yeah.
As of now it's been Okay. I mean, we're still dealing with the logistics issues and things to get product into Europe, and North America, but nothing on that front at this point.
Thanks, so much thanks for fitting me in as I said.
Thank you.
And thank you and ladies and gentlemen, this now concludes our program.
This concludes today's conference call. Thank you for participating you may now disconnect.
Yeah.
Yeah.
Okay.
Sure.
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