Q1 2022 Flowserve Corp Earnings Call
Please standby good day.
And welcome to the Q1, 'twenty 'twenty too low for the Corporation earnings Conference call.
The conference is being recorded.
This time I would like to turn the conference over to Jay Rus, Vice President Investor Relations and Treasurer. Please go ahead Sir.
Thank you Sarah and good morning, everyone.
We appreciate you participating in our conference call today to discuss flow serves first quarter 2022 financial results.
On the call with me. This morning are Scott Rowe <unk>.
<unk>, President and Chief Executive Officer, and Amy Sweats, Senior Vice President and Chief Financial Officer.
Following our prepared comments, we will open the call for questions. As a reminder, this event is being webcast and the 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 May 3rd 2022, 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 a 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 flow serve 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.
Thanks, Jay and good morning, everyone. Thank you for joining our first quarter earnings call.
I wanted to start with an overview of our bookings and then quickly turned to our global operations in the first quarter results.
Clearly the highlight of the first quarter was our success in capitalizing on the improving demand environment.
The award of several midsized projects, which contributed to flows sort of achieving its highest bookings level since the second quarter of 2019.
First quarter bookings of $1.09 billion increased 15% over prior year and about 18% on a constant currency basis. This level was also up 12% sequentially compared to last year's fourth quarter, which was the highest bookings quarter of 2021.
As a later cycle company, we're encouraged by the demand improvement that we've seen in our served end markets this year and our ability to profitably win those opportunities.
Based on the trends we are observing today, we believe that these market dynamics will remain strong in the coming months let.
Let me now turn to our global operations.
The first quarter was significantly more challenging than we had anticipated in mid February throughout the quarter, the global operating environment got worse and inflation accelerated.
The combination of supply chain constraints logistics disruption labor availability headwinds and significant inflation inhibited our ability to serve our customers and recognize revenue.
As a result increased under absorption and higher cost eroded the margins in the quarter, the Russia, Ukraine situation added further complexity to our operations.
Together these factors combined with general volatility drove our backlog conversion performance significantly below historical norms in.
In the quarter, our conversion fell to just 41% with all regions and facilities impacted at similar levels.
You put that number in context, our 2021 backlog conversion averaged 46%.
We are taking significant actions to restore our revenue conversion rates at historical levels and improve our overall margins.
Everyone in our organization, including myself is fully focused on working through this challenging situation.
We have implemented revenue cadence meetings at all levels of the operation.
Tiger teams for problematic categories.
Other procured items enhanced our planning capabilities.
Accelerating our recruiting to fill open positions and finally implemented our second price increase of 2022, which is now in effect.
Additionally, we have removed distractions and delayed internal programs to allow our operational teams to remain completely focused on running the business.
While the challenges are large in the external environment remains highly dynamic and confident in our ability to work through these issues we.
We have a talented team who have been working tirelessly to support our customers and our company.
Wanted to personally thank the flow serve associates for all of their recent and future efforts for their commitment to flow served during this volatile time.
Let me now return to the details of our first quarter results starting with bookings.
Yes, MRO activity was solid during the quarter, which supported our delivery of 18, 6% year over year growth in aftermarket bookings.
The $542 million of aftermarket awards, we obtained in the first quarter marked the highest quarterly bookings level, we have secured since 2014.
The growth in aftermarket bookings represents a positive contribution to our full year financials and it comes with it as it comes with higher margins and shorter cycle times than our original equipment work.
Last quarter, we discussed the significant opportunities presented by larger projects that had been placed on hold their customers due to COVID-19 related impacts in volatile commodity pricing we.
We are pleased the poster was awarded several midsized projects in the first quarter of this year each about $30 million in size plus a larger award of around $50 million.
Projects spanned across several of our traditional end markets, including LNG mid and downstream oil and gas and nuclear power.
The return of this more normalized market environment, coupled with our efforts to capture the available opportunities drove our original equipment bookings growth to 11, 5% or $544 million.
We also generated bookings traction through our new three D growth strategy, which we launched at the beginning of the year. This strategy was implemented to take advantage of the changing landscape and to accelerate <unk> growth.
It is our focused effort to further diversify our end markets assist our customers on their decarbonization journey and capitalize on the digital movement within flow control we've.
We've made great progress in the first quarter as our dedicated team capitalized on each aspect of the strategy.
Looking ahead I'm confident we can deliver improvement in our traditional end markets as well as accelerate closer to growth through the new <unk> strategy.
Now, let's speak further to this strategy and some of the progress we've made on it later in my prepared remarks.
This quarter's strong bookings generated at quarter end backlog of $2 2 billion, which is the highest level. We've had since the third quarter of 2015 and is up 8%, 18% year over year. Further we are encouraged by the level of MRO aftermarket three D. In traditional project opportunities that we see on the horizon.
Taken together, we believe these factors position closer well for revenue growth and improved financial results moving forward.
Looking now at our bookings performance by end market.
<unk> served market oil and gas first quarter bookings were up over 36% year over year. This improvement was driven by over $120 million of project bookings.
As well as several awards from our <unk> growth strategy.
Power bookings were solid increase the over 65% compared to prior year and included some fairly significant nuclear aftermarket and OE project awards, representing bookings in excess of $70 million.
Water bookings a key part of our diversification plans also provides a year over year growth of 12%.
General industry bookings were down 6% and finally following last year's strong performance chemical bookings were essentially flat year over year.
From a regional perspective, our first quarter bookings growth was driven primarily from the middle East and Africa, Europe , and North America, which were up 51%, 45% and 9% respectively.
Asia Pacific was essentially flat, while Latin American bookings declined 12% versus last year.
Turning now to first quarter results and operations as you will recall, we indicated on our last earnings call that the quarter would be soft and it was we faced a very challenging operating environment driven by further supply chain logistics and labor availability headwinds and cost.
All of which were exasperated by continuing COVID-19 impacts.
We experienced a number of significant direct and indirect COVID-19 impacts in the quarter first roughly 20% of our associates contracted the virus in the first six weeks of the year. This was a higher infection rate than we had seen in each of the full years of 2020 or 2021.
While the <unk> severity and duration of illness illness was much lower than what we experienced in prior years the effect on our and our suppliers employees and facilities, particularly in North America, and Europe rippled through our supply chain and operations. In addition, with the higher number of our associates impacted we authorized significantly more overtime for those.
Available, adding further costs, we also utilize much more heavy airfreight the normal to minimize the impact to our customers.
Well, we took as many extraordinary actions as possible the combined factors disrupted our ability to complete and ship product at our typical cadence.
<unk> subsided in North America through March and April However, our cases in Europe currently remain high, particularly in Germany, where they reached their highest level in April since the pandemic onset also the current lockdowns in China are impacting our local Chinese operations and a large percentage of our supply chain, which further exacerbates the issue.
With global Sea freight as the Shanghai ports remain closed.
The conflict in Ukraine began right as we were reporting our fourth quarter results since that time. It has continued to add further complexity to our operating environment.
Our team has dedicated significant time and effort in addressing the issues there isn't by it in the various impacts it has on our business.
We will cover the financial details, but we made the decision to permanently cease the operations of our Russian subsidiary.
We have also stopped accepting new orders for Russia entities and cancelled or suspended fulfillment of existing orders in our backlog.
In addition to the financial impact of these challenges.
There will be an ongoing opportunity costs associated with loss potential New awards revenue and profit, but we are affirming our decision to indoor activity in Russia.
Well closer does not operate.
Or have operations in Ukraine, we have provided provided humanitarian support through our contributions and the actions of our European Associates.
In addition to these ongoing issues global logistic lead times and availability deteriorated throughout the quarter, even as the transportation costs were increasing and higher energy prices.
The rapid inflation, we saw in the first quarter has led us to increase our full year inflation expectations by nearly 50% above what was originally planned at the end of the year. We now expect the full year cost of procured items to increase in the high single digit range year over year with the electronics motors raw materials and freight being the most impacted.
Over recent weeks I have visited at least a dozen of our sites to review the operations and ensure teams are best prepared to navigate the current environment.
Most of it's particularly complex as we operate in over 50 countries have a significant supply chain presence in China and other parts of Asia and move products and components from site to site within the <unk> network.
As I stated before we are 100% focused on unlocking the revenue available from our highest backlog level since 2015 and improving our margin performance. We have to work under contract already and we are determined to mitigate the current conditions shift the product and recognize revenue.
Before I go into the outlook for the remainder of 2022 and the details of actions. We are taking to support revenue growth and to deliver improved margin performance through the remainder of the year. Let me first turn the call over to Amy to address our financial results in detail and our updated guidance.
Thanks, Scott and good morning, everyone. As Scott discussed we are pleased with our success capturing awards and the current strong demand environment and building our highest backlog level since 2015.
With that said, we continue to face a number of challenges in the first quarter that impacted our financial performance.
We walk you through some of the key drivers of our results.
Our adjusted EPS of seven cents in the first quarter was primarily impacted by lower than expected revenue of $821 million and the related under absorption.
The light revenue was due primarily to continued supply chain and logistics headwinds and labor availability disruptions driven by Covid absenteeism and pockets of tight regional labor market.
The Russia, Ukraine situation and the current logjam in Chinese ports further impacted our ability to ship in the quarter.
On a reported basis our loss per share this quarter at 12 reflected 16 cents per share impact related to our decision to fully exit from Russia.
We also adjusted for below the line FX losses at <unk> and very modest realignment game.
As we described in our 10-K filing and press release, we are taking actions to close our Russian CRC as well lets terminate our contractual obligations and the country, resulting in a predominantly noncash charge of $20 million.
Associated with this action, we also removed about $25 million from backlog on existing contracts, we have or anticipate we will cancel.
As Scott highlighted our comprehensive flow control portfolio combined with our strong customer relationships were key in supporting our ability to leverage the end market improvement we're seeing.
This combination drove nearly 15% bookings growth year over year or 17, 6% on a constant currency basis.
Spt's strong bookings growth of over 20% in both original equipment and aftermarket orders, what's the primary driver, including your capture at several delayed project orders in the oil and gas and nuclear power markets.
FCB contributed modest constant currency bookings growth and as you may recall FCB typically benefits from project, where a quarter or two later than F. P. D. Given its comparatively shorter lead times.
Additionally, youll recall, the FCB saw a nice recovery last year, and it's MRO business.
Represents a more challenging comparative period.
<unk> first quarter revenue declined four 2% or 2% constant currency impacted by the previously discussed the operating headwinds and included low single digit declines in both S. P. D N S C D.
While we clearly have the work available in backlog its supply chain and logistics issues as well as the labor constraints limited our ability to ship and record revenue.
Both segments topline declines, where geographically driven by Asia Pacific and the Middle East Africa, and Europe , while the Americas contributed high single digit revenue growth in both MPD and FCB.
From a sales mix perspective, OE shipments as would be expected, we're more impacted by the operational headwinds with both FPV and FCB down mid single digits.
Shorter cycle aftermarket sales were less affected down a modest two 8%.
After market accounted for 53% of sales in the first quarter at five years.
Turning now to margins.
First quarter adjusted gross margin decreased 370 basis points to 26, 7% with FCB and SPD contributing 510, and 290 basis point decline respectively.
The decrease was primarily driven by approximately $26 million of expense related to under absorption due to lower revenues as well as the previously discussed material and logistics inflation and labor shortages as well as the frictional costs, we incurred to minimize disruptions to our customers.
On a reported basis first quarter gross margins decreased 380 basis points to 25, 5%.
This was due to the headwinds discussed earlier, plus the $10 million of charges related to our exit of Russia, which together offset the $9 $6 million benefit or decrease realignment activity versus the prior year.
First quarter adjusted SG&A was largely flat with prior year on continued tight cost management, but increased to 130 basis points as a percent of sales to 23, 9% due to the lower revenue level.
Group cost structure has closed are well positioned to leverage the expected near term growth that we plan to deliver as we work through labor and supply chain headwinds and increased our backlog conversion rates.
On a reported basis first quarter SG&A increased a modest $8 million year over year, which included $10 million of Russian related charges, partially offset by the $4 million decline in realignment expenses.
First quarter adjusted operating margins of three 3% decreased 480 basis points year over year with both FPV and FCB down roughly 350 basis points driven primarily by the decline in adjusted gross profit.
First quarter reported operating margins decreased 560 basis points year over year to <unk>, 9%, where the previously discussed challenges in Russia and related charges of $20 million were partially offset by the $14 million reduction have realignment spending.
And on taxes, our first quarter adjusted tax rate of 22, 2% was in line with our full year guidance of 20% to 22%.
Turning to cash and liquidity as we had forecast cast on our last earnings call first quarter operating cash was a use of $27 million, primarily due to a build in working capital of $64 million.
With the $226 million in sequential backlog growth, we use roughly $50 million for additional inventory and net contract assets and liabilities to prepare for the new work and to increase our safety stock as we work to capitalize on the strong demand environment. We are seeing in our served end markets.
As a percent of sales first quarter working capital improved to a modest a modest 20 basis points year over year to 29, 4%.
And while the strong bookings environment and backlog growth has driven increased inventory I'm pleased that our focused inventory management drove sequential and year over year decreases in total inventory, including net contract assets and liabilities as a percentage of backlog by 130, and 740 basis points to 32.
2% the lowest level since the second quarter at 2019.
In spite of our seasonally lower first quarter cash flows, we maintain a strong liquidity position, including $576 million of cash and $384 million of available credit facility capacity.
Finally, other significant uses of cash in the quarter included discrete foreign tax payment of $30 million dividends of $26 million capital expenditures of $14 million in term loan amortization of approximately $8 million.
Turning now to our revised 2022 outlook, we are adjusting our guidance range is based on a number of factors, including the ongoing supply chain and logistics challenges.
Hiring challenges in certain key locations the opportunity cost of boss Russian work and the continued COVID-19 related lockdowns in China, and the disruption it is causing in airports and global supply chain.
The headwinds are partially offset by what we expect to remain a stronger demand environment.
As a result of these factors, we now expect full year adjusted EPS and the dollar 50 to $1 70 range on full year revenue growth of 5% to 7%.
The revised revenue range is not only impacted by the loss of expected revenue from Russia, but also by the impact of the strengthening U S. Dollar.
Clearly our revised guidance represents a significant improvement compared to our first quarter results.
Key assumptions to our outlook includes modest progress towards our historical backlog conversion rate.
As well as the impact of our latest price increase beginning to benefit us in the third quarter.
By chain driven delays are also expected to stabilize as we exit the second quarter and then even further through the second half of the year.
Additionally, we expect shipping conditions to improve and gradually turn returned to normal including at the ports in China, which are currently impacting our customer and supplier shipments as well as our internal site to site supply chain.
The adjusted EPS target ranges exclude $20 million of charges related to our exit of Russia, and our expected modest realignment expenses of approximately $10 million as well as potential future items that may occur during the year such as below the line foreign currency effects and the impact of others.
Street items, such as acquisitions divestitures special initiatives tax reform laws et cetera.
Including the Russian exit charges expected realignment spending in the first quarters below the line FX impact we now expect our reported EPS in the range of $1 25 to $1 45 per share.
Both the reported and adjusted EPS target range is also assumes current foreign currency rates reasonably stable commodity prices that continuation of current market conditions and no significant improvement in the Russia, Ukraine conflict and expectations for our customers to continue to release larger project work in the second.
Third quarters.
We also continue to expect net interest expense in the range of $45 million to $50 million and an adjusted tax rate between 2022%.
You can find all of our guidance metrics in our press release and earnings deck.
In terms of phasing considering closers traditional second half weighted earnings and cash flows our results in the first quarter. We now expect this pattern to be more pronounced than our initial guidance systems and supply chain logistics and labor availability availability issues are expected to improve.
Throughout the third and fourth quarters.
And as our revenue conversion accelerated absorption levels improved and frictional costs are reduced we expect to exit the fourth quarter with operating margins in the low double digits to low teens.
As such due to both the expected ramp in volume and sequentially improving margins. We are forecasting a nearly 80% of our full year earnings range will be generated in the second half of the year.
Turning to our expectations for major planned cash usages during the year, we continue to expect to return over $100 million to shareholders through dividends.
We also intend to further invest in our business with capital expenditures in the $60 million to $70 million range, including the continued build out of the enterprise wide. It systems to further support our operational and productivity improvements. Additionally, we will continue to invest in our <unk> strategy to diversify decarbonize and digitize.
Where we delivered solid Q1 bookings progress related to energy transition and other targeted markets. Let me now return the call to Scott.
Thanks, Amy I want to first provide an update on our progress delivering on our three growth strategies and close my remarks, with our commitment and actions to meet the revised 2022 financial targets.
As I outlined last quarter, our strategy to diversify decarbonize and digitize, where the three digit growth strategy supports it aligns directly with flow serves longstanding purpose statement to provide extraordinary full control solutions to make the world better for everyone.
To be clear, we continue to fully support our customers in the traditional markets, where we continue to expect long term growth.
<unk> strategy is designed to allow us to capitalize more broadly on the opportunities available within the entire full control space by addressing our customers' increased focus on efficiency and providing the flow control solutions that enable the energy transition journey we.
We believe this strategy will help us deliver accelerated in outsized growth, while also providing improved resilience for full service business model through various in market cycles before.
Before highlighting the progress we have made in each of the strategic pillars.
To note the passion and support for the strategy I've seen from our associates and our customers.
The diversified leg of the strategy includes aggressively targeting and expanding the reach of our offering in previously underserved regions and markets that exhibit attractive long term growth prospects like water specialty chemical and other general industries, where we maintain strong capabilities.
Specifically in the first quarter, we supported a specialty chemical manufacturer in China by supplying a variety of closer valves to be used in the production of engineered plastics for automotive and electronics industries.
We also formed a partnership with gradient developer and supplier of advanced water wastewater and desalination systems, both service supporting gradient with flow control technology and products to provide efficient and reliable water systems.
Partnership is designed to provide us opportunities in previously underserved regions and positions us extremely well in various water markets and project opportunities.
Next is our Decarbonize strategy. This is an effort to capitalize on in assisting our customers carbon and energy reduction efforts closer or is uniquely positioned to enable the full control aspect of de Carbonization C. O two emissions reduction and flow loop energy efficiency. As an example, we were recently awarded a.
Project in Europe , utilizing closer to pumps and the recycling of plastic waste into sustainable chemicals for use.
Upon completion the facility is expected to convert over 1 million tons of plastic waste annually into sustainable chemicals.
Most of it is also supporting carbon capture and storage, which is an area, where we have supplied flow equipment.
The oil and gas operations for decades, the increased use of this technology in other industries over the coming decades is expected to play a significant role in the world de carbonization efforts.
We're recently awarded a contract to supply our control valves for a portion of Norway's first cross border and open source carbon capture and storage facility. This is an exciting project and it is the first project to capture and permanently store Sidoti you had a large scale.
We will apply our flow control knowledge and expertise to this project and leverage this experience on future <unk> projects.
Finally, the Digitization effort represents our focus on the growth opportunities driven by our Red Raven Iot platform in the value creates for our customers.
While the offering has only been in the market for a little over a year, we continued to gain traction with new and existing customers.
We are currently operating 45 customer sites across our core end markets. We've now submitted nearly 1500 pumps valves and seals with Red Raven and the first quarter alone. The system provided over 4000 alerts or notification to customers, which triggered incremental aftermarket product and service opportunities for closer.
In one example, we recently deployed our Red Raven technology on an offshore application in Malaysia.
As part of a long term service agreement with a major oil and gas customer where instrument in 56 pieces of critical flow control equipment across 12 with their offshore platforms.
We will continue to focus on instruments, our existing installed base as well as new equipment with the goal of converting our solution to a profitable recurring revenue stream, providing increased pull through of aftermarket opportunities.
Turning to our market outlook for the remainder of the year as I mentioned earlier, the global macro picture in our pipeline of run rate and project opportunities supports our expectation that we'll continue to see strong demand from our customers as we move forward in 2022.
We believe the improved project environment, we delivered on in the first quarter will continue for at least the second and third quarters, However, should inflation and interest rates increase beyond current expectations project investments in awards in late 2022 in 2023 could become pressure.
Regardless, we do expect utilization rates of our oil and gas and chemical customers to remain high providing strength through our aftermarket and MRO business. We will also continue to capitalize on the energy transition investment in three D opportunities, which are driven by climate change targets and ESG commitments as well as an increasing cigna.
<unk> desire for energy independence.
The conflict in Ukraine, and Russia sanctions has only accelerated the desire for energy independence in both traditional energy markets as well as new cleaner energy sources. We continue to have more discussions and have seen new projects added in this space as the world Repositions away from Russia and to a more secure source.
We are now attracting over $450 million of energy transition opportunities in 2022.
This amount does not include the significant ramp we have seen the proposed LNG opportunities or the potential growth in new pillar, we see over the next couple of years.
Closer to broad flow control offering supports our customers' energy transition ambitions as well as provides the flow control technology to support the goal of the energy independence significant energy investment is expected in the coming years enforcer is well positioned to capitalize on this growth regardless of the energy source.
Before closing, let me confirm that our most urgent near term priority is converting our strong $2 $2 billion backlog at a more normal conversion rate, while expanding the realized margins.
As Amy and I, both indicated earlier the decline in the percentage of black backlog conversion to revenue coupled with the frictional costs, we incurred to work through the many recent challenges had a significant impact on profitability in the first quarter as.
As we exited 2021, we were roughly price cost neutral following several price increases in surcharges.
With the rapid inflation, we experienced in early 2022, 5% price increase that we implemented to begin the year was not adequate to cover the increases and the incremental costs, we expected to incur in 2022.
To return closer back to at least neutrality, we recently announced and implemented our second price increase of 2022, which we expect will begin flowing through in our third quarter financials. However, we would note that only about half of our sales are priceless driven and benefit from these increases while the other half of our work is typically either.
Priced under a cost plus model or under long term agreements.
We are also repositioning and expanding our supplier base, where appropriate to mitigate the expanded lead time environment and provide more certainty around delivery predictability. We are further updating our planning tools enhancing our strategic inventory with forward purchases and expediting critical materials and components.
In closing, while the first quarter was a truly unprecedented operating environment for flow serve we are working with a sense of urgency to address the challenges facing the business.
We continue to expect the closer we will deliver solid bookings in this market and I am confident that our leadership and operating teams are prepared to navigate through the current market headwinds impacting our operations.
We expect to drive substantial sequential quarterly improvement in our phase <unk> results, which should position us for a strong back half of the year.
To enter 2023 with strong momentum.
The second quarter is a critical first step and I feel confident that our team will deliver meaningful progress in the second quarter most.
Most importantly, we have the highest level of backlog in years. So the work is there for US we have a strong leadership team and dedicated associates are committed to delivering for our customers and for our shareholders. Additionally, the near term demand outlook remains strong for our traditional markets and we believe our <unk> strategy progress will only accelerate our growth trajectory.
In short the market fundamentals of our served end markets remained strong influencer is well positioned to drive long term value for our associates customers and shareholders in 2022 and beyond.
Operator, this concludes our prepared remarks, and we'd now like to open the call to questions.
Thank you.
I'd like to ask a question. Please signal by pressing star one on your telephone keypad.
If you're using a speaker phone. Please make sure. Your mute function is turned off to allow your signal to reach our equipment again that is star. One if you would like to ask a question. It will pause for just a moment to allow everyone an opportunity to signal for questions.
And we'll take our first question from Deane Dray with RBC capital markets.
Thank you and good morning, everyone.
Good morning Deane.
Hey, Chris.
Congratulations on the order growth and a couple of questions there.
Get a sense that there were any share gains.
Winning those orders and can you take us through.
Qualitatively, if you could the embedded margins and backlog today.
Parse between OE and aftermarket.
Sure. Thanks Deane.
We're excited about the bookings level in Q1, and like we said there is a nice mix of both aftermarket and projects.
What I would say on the pricing side or the embedded margins on both sides of these on the original equipment, we've been very focused on making sure that our pricing does accommodate.
The latest cost increases and so I think we've seen.
We'll see nice progression there and now what we've got to make sure that that frictional cost of delivery doesn't erode those margins and so again I think we priced it well, we've just got to execute and streamline that execution without some of the frictional costs that we saw in Q1.
And then I'd also say the mix of projects and we spotlighted this like LNG and nuclear and other type of work.
It does contribute higher margins in some of the other end markets and so again, we feel pretty good about the margins that we booked in Q1, certainly on the project side and then on the aftermarket side, we feel good about the margins in backlog there that that should be up as we think about whats happened in that product and when it is much shorter cycle.
So typically on the aftermarket side, we're delivering anywhere between two and six weeks and so our ability to price for that accurately and minimize the disruption in the operations feels really good right now and then with $540 million of Aftermarkets, we get a nice tailwind on the mix as well so net net.
Barry.
Got it you got to execute we've got to eliminate some of the frictional cost, but if we do that that that gross margin in the product should be there.
It should drive higher margins as we think about 2022.
And do you think you gained share.
Yes, sorry, I didn't answer the share one yeah, it's it's hard to say in one quarter for winning or losing on share.
But those were very competitive projects that we won and we feel good about taking that.
And taking that work and so that part we feel good.
We certainly was the work that we targeted and then on the aftermarket side or the MRO side I think we had $540 million that level does suggest that we're winning share in both our seals and the valve MRO and so we feel good about our ability of winning share in those two parts of our business.
Got it and just as a follow up question where is the weakest link.
In the sourcing side for you all today is it.
Concerns about China, and the shutdowns because.
The extent to which you're moving product sourcing product is that the area of biggest concern.
Sure. It really is and it's primarily around Asia and then so your full serve has a large percentage of our supply chain is tied to China and greater Asia and so as we think about that and you are not only trying to get product out of there to support our existing businesses in Asia, but actually exports.
That product around the world it becomes really difficult for us and so we have an extended supply chain. There. The current disruptions of Shanghai in that region are certainly impacting our ability to get that product into our sites and our operations and so that's really the challenge and we're working on is repositioning to me.
More local or regional suppliers. We're now qualify new vendors that are closer in proximity to our operations and then we're working hard to get product out of China, and that's you know right now Unfortunately, very very difficult, but we're finding ways to get different aspects of our product out of there and we didn't shy.
I think theres a couple of key components that are really important to us the first would be electronics and so a lot of the electronics are coming out of China. Secondly is motors and while we are buying our motors predominantly from big name European and U S type companies a lot of the sub components.
In the motors are coming out of China, and then third we've got a large portion of our castings tied to China, and India, and so that longer supply chain on castings, which is basically the foundation for all of our product in pumps and valves becomes becomes a <unk>.
Source of concern as we're moving that product over over a longer than extended.
Our routes into our manufacturing in North America and Europe .
Thank you for all that color I appreciate it.
Thank you and next we'll move on to Andy Kaplowitz with Citigroup.
Good morning, everyone.
Yeah, Hey, good morning, Scott you had mid teens bookings growth in Q1 versus the guidance for the year. I think you had was high single digit bookings growth do you see the rate of bookings growth in Q1, continuing or could even accelerate from here and I know you mentioned inflation as a possible headwind on awards.
I mean that from your customers and then obviously your oil and gas bookings in your power bookings look like they took a nice jump in terms of percentage of bookings in the quarter. So maybe give us some more color into how you're thinking about LNG nuclear power opportunities going forward.
Yeah Yeah.
Andrew we're in a really interesting time here on bookings.
We feel really good about the activities out there and you know clearly Q1 was a nice start to the year, we've got great visibility to projects and so we have that now for a couple of quarters. Some of those kind of slipped a little bit more than we expected, but we're now starting to see those line up and part of that is that under <unk>.
<unk>, we've seen over the last two years and so I feel good that those projects continue to move forward. There is many that are very close to <unk> and then you couple that now with what's happening in Russia and Ukraine. In this strong desire for energy independence, and so this is going to drive LNG or it will I'll say it will accelerate.
G dramatically and we're seeing that we saw awards in the first quarter and we expect more awards in the back half of the year in fact, our pipeline and LNG just for full suite of products is over $300 million.
It's the largest we've seen in a very long time. In addition to that we saw nuclear work in the first quarter and we expect further nuclear work in 2022, our pipeline on nuclear is up as high as we've seen in over a decade and so I think this this desire for energy independence is absolutely going to help us on the booking side.
The concern I would put this in the prepared remarks is that at some point the inflation and interest rates factor in to the viability of these larger projects and what I don't know right. Now is when do we start to see that what I'll say is our customer discussions right now are not indicating any slowdown they indicate.
That the business continues to move forward and they continue to spend money, but at some point that the price of putting one of these large scale projects together, we will overcome the returns when you're in a deflationary environment of high single digits.
And change that we saw in the first quarter.
And then let me also address the MRO and aftermarket we had a really nice number there in Q1 I think the current utilization rates of both the refining and chemical sector as well as the other aftermarket and MRO work that we do I don't see that going backwards here throughout the year and I'm not sure it accelerates dramatically.
<unk>, but I certainly think we can hold this level of aftermarket business as we progress through 2022.
Scott that's very helpful. And then let me ask you will fall to Dean's question. He asked about China, but let me just ask you in general about the second half earnings ramp.
You mentioned modest progress in terms of backlog conversion, but are you assuming conversion gets back close to normal levels at some point in the second half and I think Youre frictional costs, you called out were almost $20 million in Q1, whats your expectation for how frictional costs will trend in the second half of the year.
Yes, I'll, let Andy answer that she's got the bridge on our our forward look for the year. Yeah. So I think as we think about that that earnings ramp a couple of things to keep in mind I mean, one generally flow service typically between 55 and 65% second half weighted from an earnings perspective.
Getting out of the gate with with seven of adjusted earnings is automatically going to weight our earnings more than that towards the second half of the year. We are not assuming that in the back half of the year that things get back to normal.
But we are assuming a couple of things happen as we look at that one that the supply chain situation stabilizes.
An improved modestly so we're going to see lead times get back into the stable.
Stabilized during that period of time, and we also suspect that logistics and then we will stabilize and improve and improved slightly from a conversion rate perspective, we're not anticipating that we'd get back to historical levels.
But once again, we are expecting modest improvement in those conversion rates, so and even with what we're anticipating in the back half of the year, particularly in the fourth quarter will be well below our historical rates from a frictional cost perspective, there's two things that we can do that will be.
Incredibly impactful for us in.
In terms of limiting those frictional costs going forward.
The first is as we mentioned the Covid absenteeism and those pockets of regional labor shortages getting that labor to a more stabilized level.
In those areas and the second is around is there is around cost choices with with logistics, so our ability to stop expediting everything.
In choosing the most effective and the most effective way to transport material to our sites will be will be important we're anticipating that with this last price increase we're going to largely cover cover any other inflationary impacts that we're seeing and over the course of the year and then the.
The last comment I'll make in a really long answer I recognize is that as we've talked about these large project bookings, increasing and that OE mix.
And that OE market, returning that's incredibly helpful to us in terms of having our plants to operate at a more optimal level. So did some of the under absorption under absorption issues that we've seen both last year and that were exacerbated this quarter by some of the supply chain issues.
And the labor shortage is we're going to see those improve sequentially over the course of the year, which is going to help us expand our margin.
I appreciate all the color.
Okay.
Thank you and next we'll take a question from John Laws Credit Suisse.
Hi, good morning, and thanks for taking the questions.
Maybe.
Maybe first question.
<unk> the each one to each to earnings.
Commentary can you help us understand what the sales split.
That's associated with that is just so that way we can calibrate.
How you're thinking revenue growth sequentially from the first quarter.
Sure. So so certainly fail similarly are going to be second half weighted but not to the extent of earnings so as we start to see things.
And.
Normalize or stabilize and maybe a better word over over the second half of the year. We are anticipating that that those incremental margins improved sort of in excess of that at that revenue growth as we see as we see stabilization.
Great.
Yes, maybe if I ask it differently do you see sales sequentially growing each quarter as you go through the year is that how we should think about the cadence. Yes. So I mean, I think you could you could draw you could draw a line in our second quarter will be more than first quarter and third quarter at the same in fourth quarter as is traditionally the case will be.
And what will be our highest quarter of the year and that's traditionally been the case. It was the case in an in in 'twenty.
In 2021, and we'll see that pattern continue I will say it at the fourth quarter revenue levels. It certainly levels that we've that we've operated at in in the not too distant past and we feel confident that we should be able we should be able to deliver on.
Great and then maybe just a question more broadly around managing supply chain can can you just remind us as an organization you know where you are managing that from is it you know at the corporate level is it down at the business level the segment and then.
Maybe any kind of cadence on meetings.
That would go up to the C level.
Yes for sure.
I'd say, we're like we manage our supply chain like many others. We've got a group that runs the central supply chain that's.
That's at the corporate level, it's not incredibly large group, but what their job is to set the strategy our supply chain and they also do category management and they do supplier quality as well and so when you think about like adding suppliers are managing our large partner in preferred accounts than that team would do that activity and then embedded in each of the <unk>.
Visions as their own supply chain organization that would be responsible for executing at that divisional level, and then really that they're more tactical procurement and management of the orders resides at our manufacturing plants and so we've got it kind of tiered and then I'd say from a meeting cadence standpoint.
We went from two years ago, where I I would never have to sit in on these type of meetings to where now we're doing a weekly meeting with the president and the head of operations and supply chain to make sure that we're working through this as efficiently as effectively as possible and so we've got a ton of visibility to where we're challenged and we're.
Putting different programs and things in place to start to restore that we put a slide in the deck that talked about the short term and the long term things that we're doing and the initiatives to focus on supply chain, but I would say really it's everything's on the table, we put more resources towards expediting.
Put more resources to category management, we formalized some of the things that were I would call you know maybe not as formal as it used to be and then we've actively qualified new vendors that are closer in proximity to our different regions, where we operate and then on the longer term.
I would say this.
We've been working on this now for six to nine months, but on the long term. We know we've got a reposition our supply chain to more regional focus and so that that won't happen overnight, but it's an area that we know that we've got to do this we've already started to reposition and create more redundancy and resiliency in the supply chain.
And then secondly, we've got to enhance our strategic relationships and our partnerships. So we did a lot of this work in closer to point out to create what we call partners and preferred suppliers and essentially that's just having more of a partnership under managed spend rather than having reactionary purchase orders and so we're expanding that were considered.
Then we're basically now you are really looking at how do we have even deeper relationships and partnerships with the right suppliers.
So all of those things are going and then finally, the other big thing is just continuing to advance or enhance our planning tools and competencies and so.
Uncertain environment.
Planning becomes absolutely critical it's a competency that full serve has made good progress over the last five years, but it's something we've got to continue to invest in and get better yet and so we're spending a lot of time talking about how we plan our work and planning for the future.
Great I appreciate the detailed answers thank you.
Thank you and next we will take our question from Nathan Jones with Stifel.
Good morning, everyone.
Hey, Nathan.
You've got the whole situation going on with China at the moment I think we probably are barely even started to see the ripple effects.
What that's going to do to supply Jamie two Q3 Q4 Q today.
You're talking about stabilization and maybe some modest improvement in supply chain in the back half of the year is there anything that you're seeing at the moment that that leads you to that conclusion or is that just.
And then an assumption that you are building into the way you're guiding.
Investors out there at the moment.
So I'd say you know clearly we are seeing some stability Amy put this in their car.
In her comments and one of the answers stability is probably the first step that will allow us to do what we think we can do to improve revenue and drive better conversion. We are seeing that in parts of the world and in some of our commodities, where things are not necessarily getting a lot better, but theyre getting more predictable.
And we're not seeing the changes in lead times, and we're seeing the more accurate deliveries from our suppliers or from the logistics side. So I do think things are settling down we definitely need that to progress as we go forward.
Single biggest concern for US right now is China and the unlocking of the Shanghai area. So today our facilities in Suzhou remained open however, it's very difficult to transport product or people anywhere within in that region in China, and so there's definitely additional risk if we don't see China.
Opened up at some point in Q2, so our assumption is that we do open up in Q2, we've got good visibility to what we need in the orders and the demand in there.
If it doesn't open up in Q2, then we have additional risk in the back half of the year.
Just to give us more color on that with respect to our segment reporting F. C. D. In particular is is exposed to China in terms of the product that they produce both both internally at flow serves site and.
And from a and from a supplier perspective, the same is actually true with with India.
And although the situation in China.
Pain remains what I would call uncertain at best we do see the situation, particularly from a logistics perspective out of India, improving and providing a bit of a tailwind for that particular for that particular segment.
And then a follow up question on pricing.
Yeah, the short term.
MRO kind of business is not the focus here on some of that perhaps.
Project business that was priced last year.
Under a cost plus model, what's your ability to go back and extract price out of that or are we just expecting as those projects deliver here.
The margin going to are being eroded by inflation in those projects and are there any I know.
Kind of counter measures that you're embedding into.
New contracts to try and counteract the potential for further inflation.
Yeah, No. That's a good question. So just for everyone's benefit our project business, where we do cost plus pricing. That's an area that we've been very focused on to make sure that we can deliver the margins that we booked at and so the first step is you know before we we book the project reduced secure pricing from our prime supplier.
And so this should be our big castings, our motors and the big components, there and so at the time of booking we feel very good that we've locked in that cost profile for the large projects, where we get where we've seen some erosion here recently in the last six months has been on a lot of the smaller things that we normally.
We wouldn't have to worry about from an inflationary environment now those make up a smaller percentage of the cost, but there are certainly offsetting some of that margin potential and so the things that we're doing within the projects. What is our validity is now shortened substantially and so if we do see things change on a general basis, we're able to.
To adjust that and make sure that we can get that pricing into the project.
<unk>, we're now putting inflationary metrics into those quotes on the very large projects now what I'll say is that's difficult to do on the smaller projects, but on the bigger projects, we're starting to see success with the ability to put it in place and metric on there and then outside of that you know the only other.
To get additional prices just to really aggressively manage that project and if theres a change in the project that we make sure that through the change order management process that we are getting increased margin in that project itself, but you know those those projects are for us, it's a fixed price and going back in and trying to open that up.
And changed the prices is really not going to happen.
Well, you're setting is that most of your cost is already locked in at that time you booked at project.
Yeah, there's certainly all of our big cost saves that are absolutely locked in so motors castings and other things are firm costs from our supplier before we book network.
Great. Thank you.
Thank you and next we'll move on to Joe.
Giordano with Cowen.
Hey, guys good morning.
Good morning.
Okay. So on the revenue guide the the headwinds that you have the revenue from incremental FX and from the <unk> coming in below your expectation and the exit of Russia is more than the reduction in the guide so effectively you're raising the confidence in our in the rest of the year from a top line and look I know that bookings.
Quarter, we're definitely better than people were expecting and your backlog is at all time high but backlog was high last quarter and you came in under so.
What gives you the confidence that backlog alone can can drive backlog actually clearing because at some point backlog can be like infinity. It almost doesn't matter right. So what gives you confidence that you can more than offset.
So the <unk> headwinds here.
Yeah, No I think.
Joe You said exactly what it is right the bookings in the first quarter were higher than we expected a lot of that is on the MRO side that will absolutely shift within the year.
And then secondly that the backlog is there and at some point, we've got a we've got to work through that and ship. It and we also believe you go back to the MRO. We believe we're going to have a strong second quarter on MRO that was higher than our expectations and again most of the work that's booked in the second quarter on MRO and aftermarket will still ship in the year, but the big challenge.
He's got it we've got to convert the backlog at a more normal pace and as Amy said before.
Going in to these optimal levels, if you will we're showing.
What I will call a gradual increase in our ability to convert throughout the year and we think with some stability in the end markets that our teams are willing to do this in.
As I've gone to all of our sites I've gone to 12 sites here recently in the last couple of weeks.
We see a lot of products stacked up we know exactly what's missing we know what the shortages are and we've got some pretty good ability to start to convert that and I think gave me why don't you touch on just the percentage of completion of the project. So sure. So I think the other point is just on these large larger OE projects that we're booking this is not.
And this is not sort of a one and done in terms of revenue recognition. This is revenue that we're recognizing over the life of those projects as we clear milestones. So some of the challenges that we see in the current situation certainly we still have the supply chain constraints that we need to work through some of the issues in terms of customers arranging low.
<unk> and the like and we're not dependent on with respect to PSC booking so and having having a nice mix of POC with this point in time revenue recognition on on the aftermarket and MRO sales actually adds to some of the predictability of our revenue versus detracting from it.
And then just to follow on the you know I think you've mentioned many times on the supply chain your expectation for the rest of the year is that it stabilizes then it doesn't improve.
I feel like that seems reasonable, but also I feel like every time, we think we're done with like inflation is easing where COVID-19 is easing.
Getting worse, so like I guess, you have some sort of.
Edge on visibility that gives you the confidence to do that or why not just guide as if none of this stuff gets any better whatsoever, and then give you know then we have like a comfort level that now under almost any circumstance. They can deliver this now there is some sort of embedded improvement in them maybe in a in a supply chain that.
Maybe we're just hoping for just unexpected.
Yeah, and I think it goes back to stability in the volatility right and so with the volatility.
And things continuing to move that that's where we really struggled to provide shipments. If we start to see any stabilization then as lead times get pushed out or or things start to change, where we're able to actually catch up and deliver to that new extended lead times. We've got a lot of product in the system you can see that in our whip.
And the inventory and so at some point, we start to relieve that as we get the right components in the door and so again, we feel confident that we've got the visibility there. We've performed a lot of this work and it's sitting on our shop floors are in whip right now and we have the ability to convert that as we start to unlock these differ.
Supply chain vehicles, and so yeah, we just believe that as we continue to work through the year that this stability starts to help us unlock and grow our revenue too.
With that I will say is it not even that are.
What I'll call a normal conversion rate, but something that is that makes sense and we have confidence in and do it just a couple of data points. We did see receipts for example in the month of March increase versus versus what we had seen.
And.
In the previous months in the quarter, we've seen our on time delivery.
Our on time delivery performance from our vendors stabilized, it's not where we want it to be but but but it's stabilized and when you have the double whammy in that declining in lead times, increasing and it doesn't it doesn't work well and again, we are seeing a little bit of relief on the logistics side, particularly.
<unk>.
In India, which provide us some data points in terms of certain levels of improvements and then I think it's it's about where you know trying to foresee where the next issues are popping up and there will be challenges for sure but in the categories that we're looking at that have been really really impactful to.
Over the last couple of quarters, we feel like we are starting to see signs of stabilization in those particular categories.
Thanks, guys.
Thank you and next we'll move on to Joe Ritchie with Goldman Sachs.
Thanks.
Good afternoon, everyone.
Hi, Joe.
So maybe maybe just maybe just starting off.
You guys have been pretty clear in for the last several quarters that the under absorption issue.
He has been impacting your margins I guess.
What I'm trying to like gauge from here is what kind of margin improvement we should start to expect when you. When you start to see the OE orders get fulfilled and if I take a look at your order rate. The order rate has been above 400 now for several quarters and it seems that we're probably dropping it like a sub.
400 revenue number this quarter, so like how do we think about either Inc.
Incremental sequential margins from here.
Amit on OE coming through.
Or just you know margin improvement across the businesses that you start to as you start to ship some of these volumes.
And so we are anticipating you know as we look at the fourth quarter of the year that we're going to exit at sort of a 12% to 14%.
Oh I level, we'll see and that will be as a result of sequential improvement.
Over over the course of the year and as you probably heard us say multiple times, that's not the system working at.
At an optimal level.
In the fourth quarter, but getting getting some stabilization I think that you're absolutely right that where we're seeing the largest.
<unk> of under absorption or certainly in the S. P D segment and it is.
You know oftentimes at at large E T O.
Right facilities, where we've got we've got specialized labor and in place and we've got line of sight into bookings coming coming in that are that require that we continue to have and that expertise on on site and so as we start to deliver on some of these larger project bookings that we see.
I'm coming in in the first quarter, we anticipate that that that that absorption level and it's going to be it's going to be much better based on the 23% increase that we saw in OE bookings in the first quarter.
Got it that's helpful and maybe just a follow on question. There so of your exit rate of 12% to 14% I'm, assuming that's an STD.
Me, if I'm wrong, there, maybe it's maybe it's that the total segment level.
That would be.
At that level.
At our at the company level, Okay. So here at the company level, I mean that would be several hundred basis points better.
Then the exit rate last year, and I fully recognize theres seasonality in your business as well I mean is that is it fair to say, we should be kind of carrying that forward. Then as we think about you know the type of margin improvement. We should expect then next year, assuming assuming nothing really kind of changes.
From from from current.
What's happening currently.
Is that the right starting point for next year.
We expect that we'll continue to see seasonality in our in our business. Joe. So we oftentimes see that first quarter be relatively weak from a margin perspective, so I don't want to guide pretty materially to.
No no degradation from this fourth quarter level, but what the.
The thing that I would say is that we do anticipate that that 12% to 14% margin exit rate is something that we intend to build on we don't necessarily think that that's the that's the system working exactly as it as it should so as we move into 2023 will be will be.
Working to continue to improve our performance and specifically around the rate of revenue conversion and as we look.
And as we look for 2023 and.
<unk> financial performance, So I would anticipate that 2023 margins will be in total.
Higher or at that at that exit rate or better.
Okay. Thank you.
Alright, Thank you everyone for joining.
Thank you everyone for joining today's call in closing, we faced the challenging and volatile operating environment in the first quarter. Our teams are actively working through these challenges, which will position us to successfully convert on $2 2 billion of backlog the strong bookings in the first quarter combined with the increased spending we expect in our traditional <unk> growth Mark.
<unk> give us confidence that closer is now entering a growth phase we have a talented team of associates and I am confident that you will see revenue and margin improvement as we progress throughout the year. Thank you for your interest in and support of closer.
Thank you and that does conclude today's teleconference. We do appreciate your participation you may now disconnect.
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