Q2 2022 Flowserve Corp Earnings Call
Good day and welcome to the Q2 2022 flow serve Corporation earnings Conference call. Today's conference is being recorded at this time I would like to turn the conference over to Jay Ruche, Vice President of Investor Relations and Treasurer. Please go ahead.
Thank you Hello, and good morning, everyone.
Appreciate your participation.
First of all the data this.
<unk> second quarter 2022.
<unk>.
On the call with me. This morning are Scott Rowe preserves president and Chief Executive Officer and Andy.
What's senior Vice President and Chief Financial Officer.
Our prepared comments, we will open the call for questions.
Binder.
It is being webcast.
It will be available.
Please note that our earnings materials do and this call.
Include non-GAAP measures and contain forward looking statements.
Statements are based upon forecasts expectations and other information available to management as of July 28, 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 disclosure.
Well as the reconciliation of our non-GAAP to our reported results both of which are included in our press release.
And are accessible on our website.
Com in the Investor alert.
I would now like to turn the call over to Scott Rowe.
<unk>, President and Chief Executive Officer for his prepared.
Great. Thank you Jay and good morning, everyone. Thank you for joining our second quarter earnings call.
Pleased with our second quarter performance, which modestly exceeded the outlook, we provided on our last call the 30% to EPS that we delivered in the second quarter keeps us on pace to deliver within our full year adjusted EPS guidance.
Bolstered benefited from top line growth in the quarter as our incremental <unk>.
Trading margin with nearly 60% on a sequential revenue increased 7%.
Our end markets remain supportive and we delivered strong book 1.04 billion.
Primarily by aftermarket and MRO activity that is now about prepaid debit levels.
The overall operating environment.
In the second quarter, but signs of stabilization appeared late delivery, giving us renewed confidence in our second half outlook.
During the quarter bottlenecks remain for certain procured items, such as electronics soft goods and motors supplier.
Supplier lead times were still extended but have begun to stabilize providing us more certainty to incorporate their delivery dates into our production schedules and our customer commitments.
China Lockdowns continued headwind for most of the second quarter with Lockdowns easing and logistics improving late second quarter.
<unk> facilities and suppliers can start the process of restoring their production.
Additionally, our global suppliers continued to be impacted by labor ability issues and an inflationary environment that existed for most commodities and raw materials.
While we have evidence that pricing for semi they have peaked it could be starting.
Particularly as it relates to logistics materials.
The two price increases that we have implemented so far in 2022 will support our can maintain price cost neutrality for the year.
The first.
<unk> began to show this quarter and our most recent increase implemented will benefit and half of the year.
I look forward to visit many global manufacturing locations during the second quarter and saw the impact of these challenges firsthand.
It is an incredibly difficult environment to operate in and I want to thank our dedicated and devoted team for their passion commitment.
To serve our customers and drive success for closer.
With this operational backdrop the results, we delivered given the resolve and dedication of our associates around the world.
Our teams adapted in past throughout through the challenging environment by placing a high level of focus on mitigating the disruptions.
Well I think the freight costs that we had incurred in recent quarters.
We worked hard to qualified new suppliers, where needed and aggressively repositioned and expanded our supplier base.
Where appropriate we spent cash to build inventory with forward purchases and expedited critical components and materials.
These efforts helped ease the extended lead time environment and increased our ability to more accurately predict delivery times.
And we will continue to our operation as we build resiliency in our chain strengthen our planning capabilities and staff our operations to the growing environment.
The entire organization is focused on our strong backlog into revenue growth and margin expansion.
The second quarter continued a trend of solid bookings and I couldnt be more encouraged by the strength in demand for our products and services that we saw in the quarter.
In the quarter or 1.041 billion in New award delivered a year booking.
<unk> growth of 10%.
Despite the strengthening dollar the.
The growth was primarily driven by our aftermarket and run rate businesses at several of the large projects in our funnel into the second half of the year.
Utilization rates at our customers' facilities and the impact of deferrals that took place in 2020 in 2021 drove aftermarket bookings of $546 million, which delivered constant currency year over year growth of four 5%.
From an original equipment perspective bookings increased 21% from prior year to $518 million.
While we did not repeat the amount of work that was in the first quarter, primarily due to timing. We did received roughly 15 orders in the 5% to $20 million range.
All of our major end markets.
Additionally, our MRO related original equipment bookings remained strong.
While we saw several projects progressed to funding in the second quarter a few of the orders that we did expect to book in the quarter shifted into Q.
And some of the already booked.
Our project funnel for large project work over the next 12 months continues to grow in the second quarter.
With good visibility into opportunities across LNG nuclear oil and gas water.
Several desalination projects.
Finally, the buckets in a committed partner and our distributions.
<unk> provides strong bookings.
Which should be during the course of the year.
With both solid OE aftermarket bookings in the quarter, our backlog top $2 3 billion, reaching the highest level since 2000.
Level of work under contract and with our expectations of the supportive demand environment.
Issued us well to deliver strong growth and margin improvement as we move forward.
As I've mentioned.
In prior calls and increasingly confident that we are at the beginning of a multiyear growth cycle driven by a number of factors including aging.
Aging existing infrastructure pressured by utilization.
Which will require ongoing investment to maintain capacity increase efficiency and reduce youths.
Energy security and energy independence is a rapidly growing theme driven by the war in Ukraine, and it will require significant investment across our traditional markets, including increased LNG capacity and renewed interest in nuclear power.
<unk> growth in consumer data.
Well continue to drive our structure to our chemical water and general industry markets.
The global focus to Decarbonize and <unk> reduction commitments will further support investment opportunities.
I would also like to highlight that our diversification de carbonization utilization growth strategy.
<unk> bookings in the second quarter in particular saw strength in areas, where we utilize our full control keys to.
Customers de carbonization effort.
Our energy transition.
For 60 days since the beginning of the year.
Looking now at our performance by end market.
On a constant currency basis, given the strengthening dollar.
Chemicals represented the strongest market for year over year with bookings up over 20%, including two small project awards totaling $12 billion.
If oil and gas industry bookings were up over 10.
For project work in the $5 million to $20 million range water bookings were up 37% with two projects totaling more than $10 million, including a desalination project in the middle East.
Finally, our power up roughly 3% on the top 20 and compare that included a 12 nuclear award.
From a regional perspective, our second quarter bookings growth was driven primarily from North America, and Asia Pacific, which were up 19% and 27% respectively.
Europe delivered 9% growth Middle East Africa.
Africa was essentially flat finally, Latin America bookings were down roughly 10%, let me now turn the call over to Amy to address our financial results in more detail.
Thanks, Scott and good morning, everyone.
We are pleased with our second quarter financial results, which exceeded our prior expectations as well as the sequential progress we made.
While the current operating environment continues to put as many of the challenges we faced in recent quarters.
Including supply chain issue.
Logistics and other frictional costs, we are encouraged by the modest improvements in the industrial bottlenecks that we began to see late in the second quarter.
Considering the recent positive trends we continue to.
We anticipate additional progress in the quarters ahead.
That said I would like to reiterate Scott's commentary at the major catalysts for the sequential growth we delivered in the second quarter with the hard work and unwavering dedication displayed by our associates and our initiatives and efforts to mitigate the challenges in the current landscape were integral to our performance.
In the second quarter, we reported EPS of <unk>, 34, which exceeded our adjusted earnings per share due to $10 million at below the line FX gain adjust.
Adjusted EPS of <unk> 30 excludes the FX gain as well as the $3 million noncash impairment and modest realignment charges of about 500000 Gallery.
Both our reported and adjusted EPS results demonstrate the impact FY <unk> topline leverage can deliver to closer to $3.
Further our quarter end backlog is up to $2 3 billion.
An increase of 15, 6% since year end driven by year to date book to Bill ratio of one to five.
This solid foundation and our outlook for constructed end markets to continue.
Support our expectation that revenues will continue to increase in the coming quarters.
As Scott highlighted we are equally encouraged that demand for our comprehensive portfolio at flow control products looks to remain strong across all of our core end markets and within our <unk> strategy.
Specifically within that <unk> strategy, we drove solid bookings in targeted markets, including de carbonization specialty chemical energy transition and water during the second quarter the.
Combination of tailwind from our traditional end markets and accelerated growth from our <unk> strategy drove a bookings increase of nearly 15% on a constant currency basis year over year.
This bookings growth was primarily driven by improvement in our original equipment orders, which were up 21% or 27% on a constant currency basis with both MPD and SPD in that range.
Small projects move forward and distributors began to restock.
In particular, we saw solid contribution from FCB distributors, where the channel represents roughly 40% of this segment's business.
Aftermarket bookings for over $500 million for the third consecutive quarter. Despite.
Despite the strong dollar we continue to remain at or above pre COVID-19 levels as operators look to catch up on previously deferred maintenance and our sales engineers continue to add value for our customers.
<unk> second quarter revenue declined one 8% year over year, but increased two 8% on a constant currency basis.
The constant currency growth was driven by aftermarket and both segments, reflecting strong MRO and aftermarket environment of the last several quarters and stabilization in our operations.
On a sequential basis sales increased seven 4% with contribution from both contributions from both aftermarket and original equipment.
As I mentioned deliveries of original equipment has continued to be impacted by supply chain and logistics headwinds as well as labor disruptions and while each product category within our supply chain will stabilize and improve on a different timeline, we began to see modest improvements in many of these areas at the end of the quarter and our.
Expecting the positive trends will continue.
Regionally North America constant currency revenue growth over 13%, including 23, and 10% growth in SCD and SPV respectively.
Middle East and Africa, contributing 20% growth on SPD strong 32% increase.
However growth in these regions was partially offset by low double digit sales declines in Asia Pacific and Latin America, as well as the 2% revenue decrease in Europe .
Now some margin.
Second quarter, adjusted gross margin decreased 300 basis points year over year to 28, 4%, resulting in a 170 basis point improvement sequentially.
The year over year decline was primarily driven cereal and logistics inflation.
Going temporary frictional costs.
Actions to drive supply chain management improvement and increased under absorption, which were partially offset by a 102 point shift the aftermarket and the impact early 'twenty two pricing increase.
While we continue to expect to see modest progress in the overall industrial landscape for these issues during the second half of the year, we are not banking on significant improvement in these underlying global challenges.
Similar to the second quarter, our associates will work hard to minimize the macro challenges to deliver to our customers.
The lead these efforts.
With the improvements that we expect in the whole supply chain and associated costs. The impact second price increase of 2022, taking hold.
Second positive benefits that higher original equipment sales volume will have on absorption will continue and we will.
Contribute to higher gross margin for closer going forward.
On a reported basis second quarter gross margins decreased 270 basis points to 28, 3% due to headwinds discussed earlier, partially offset by a $3 million decrease in realignment charges.
Second quarter, adjusted SG&A decreased $18 million to $192 million.
Making our marking our fourth consecutive quarter at or below $200 million as a result of our disciplined cost management and a modest FX benefit.
As a percentage of sales adjusted SG&A decreased to 160 basis points to 21, 7%.
Adjusted SG&A was roughly flat despite the 7% revenue increase over the first quarter demonstrating the leverage we expect to deliver as we continue to grow in the second half here.
On a reported basis.
Second quarter, SG&A decreased $16 million year here, including the impact of an asset write down of $3 million.
Partially offset by the reduction in realized margin of roughly $2 million.
Second quarter, adjusted operating margin 130 basis points to seven 2% year over year.
With SPD down 200 basis points, and SPD down 80 basis points driven primarily.
Merely by the declining adjusted gross profit, partially offset by our SG&A management.
On a sequential basis, adjusted operating and improved roughly 390 basis points, producing a sequential incremental margin of 60%.
Second quarter reported creating margin decreased to 120 basis points year over year to $6.
Driven by the previously discussed challenges.
Our second quarter adjusted tax rate of 23% was in line with our full year guidance of 2% to 2020 at 20% to 22%.
Turning to cash flows.
Second quarter operating cash was a use of $45 million, primarily due to a build in working capital for.
$4 million on continued backlog.
Including inventory buffers as well as the timing of certain accrued liabilities.
We have used roughly $95 million.
So in the first half of the year for inventory, including net contract assets and liabilities to support the $313 million increase in backlog.
Year to date.
The combination of strong bookings growth and improved project environment and the frictional issues delaying shipments has pressured our working capital as we look to capitalize on this environment.
As you would expect the growing backlog and shipment delays have also impacted working capital as a percent of sales, which in the second quarter picked up 50 basis points to 29, 9%.
Despite this inc.
I am pleased that for the seventh consecutive quarter, we have lowered the total inventory, including net contract assets and liabilities as a percentage of backlog.
Which now stands at 32% our lowest level in three years.
Lastly, other material uses of cash in the quarter included dividends at $26 million capital expenditures $17 million in term loan amortization of approximately $8 million.
As most of you know closer traditionally uses cash in the first half of the.
But then delivered strong cash generation in the second half.
We expect the seasonal dynamics, so again play out in 2022.
Turning now to our outlook for the remainder of the year.
Based on our second quarter performance, we affirmed our target range for the full year.
However, if the U S. Dollar remains at its current strong level, we believe our financial results will likely be at the low end of the range for both our revenue and adjusted EBITDA.
Even with this expectation substantially year over year.
<unk> growth for both revenue and adjusted EPS for the second half of the year are still imply.
In terms of phasing, we expect the third quarter to be a modest improvement over the second quarter and then to finish the year strong and Q4 positioning us to enter the new year with increased momentum.
Our view is based on expectations for incremental stabilization and modest ongoing improvement in the supply and logistics challenges, we have faced for a year now as well as better cost absorption coming from longer lead time original equipment currently underway at our sites.
We are not forecasting a significant range backlog conversion rates, but we do expect combination of our strong and growing backlog and our ongoing operational progress and the continued effort by our associates.
Still planning and supply chain management as well as the impact of our main price increased two eight to support the sequential financial improvement for the remainder of the year.
Including an expected fourth quarter adjusted operating margin in the 12% to 14% range.
The full year adjusted EPS target excludes our $20 million charge to exit Russia. The modest expected realignment expense of approximately $10 million, the second quarter asset write down of $3 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 other discrete items.
Such as acquisitions divestitures special initiatives tax reform laws et cetera.
Including the adjustments incurred in the first half of the year and the expected second half realignment spending we now expect our reported EPS to be in the $1 25 range.
Both the reported and adjusted EPS range also assumes current foreign currency rates reasonably stable commodity prices.
Continuation of current market conditions, no significant improvement in the Russia, Ukraine conflict and expectations for our customers to continue to release larger project work in the second half of the year.
We also continue to expect net interest expense in the range of $45 million to $50 million and an adjusted tax rate in 2022%.
Turning to our full year expectation for the major planned cash usages, we continue to expect to return over 100 million to shareholders through dividends in fiscal 2022.
We also intend to invest further in our business with capital expenditures in the 60% to $70 million range, including the continued build out at <unk>.
E systems to further support our operational and productivity improvements.
We will continue to invest in our <unk> strategy to diversify decarbonize and digitize, where we delivered solid Q2 bookings progress related to energy transition and other targeted markets. Let me now return the call to Scott.
Thanks, David as I mentioned earlier, we are encouraged by the strength of our traditional markets as well as the opportunity to further accelerate our growth as we execute our diversified decarbonize and digitize strategy.
Our <unk> strategy aligns directly with grocers longstanding purpose to provide extraordinary full control solutions to make the world better for everyone.
The success, we have had targeting opportunities in diversification de carbonization and Digitization and the first half of 2022 demonstrates that this is the right strategy for the current environment and for years to come.
During my travels to the Middle East Europe , and the Americas My discussions with customers have validated our expectations of increased investment in these areas and our view that capitalizing on their increased investment will deliver a more robust growth profile than just our traditional markets.
One thing that became very clear from these discussions is that de carbonization is it consistently across the globe.
It is now appearing all of our end markets currently.
Currently our energy transition for the next 12 months stands at $675 million versus $415 million at the beginning of the year.
This growth supports our conviction that <unk> products and services are well positioned to serve this growing market.
Let me now discuss our strategy for each of the three provide some recent wins in these areas.
Beginning with diversified we are aggressively targeting and expanding.
Our offering in previously underserved regions and markets that exhibit attractive long term growth prospects like water because we.
Chemicals and other general industries, where we have strong capabilities in the second quarter. We were pleased to be awarded a project, providing pumps to especially chemical manufacturer in Asia for the world's first integrated poly lactic acid facility closer to us helping them to meet increasing demand from diverse markets, including three D printing.
<unk> project products flexible packaging in foodservice, where.
Decarbonize is expected to provide opportunities globally influencer is uniquely positioned to enable the full control aspect of de carbonization.
Zero, two emissions reductions and flow loop energy optimization. Additionally, we are very focused on providing full control technology and energy sources.
Therefore closer was recently awarded a contract to supply over 2000 controlling ball valves for what will become the largest commercial green hydrogen plant in the world based out of the Middle East.
Upon expectations expected completion in 2026, it will produce over 650 tons of hydrogen daily.
2 billion tonnes agreeable yet.
Which will eliminate the equivalent of 3 billion with Sidoti <unk> emissions per year.
Finally, the business is the digitized effort is our focus on the growth opportunities driven by our Red Raven Iot platform and the value creates for our customers since <unk> launch in early 2021.
Gained increasing traction with new and existing customers and are currently operating in 49 customer sites across our core end markets and a instrument roughly 1500 pumps valves and seals with Red Raven.
As an example of recent success, leading electric power generating company in East Africa.
Because the unforeseen June with one of its pumps working closely with the customer to resolve the issue we presented red Raven as an opportunity to improve operability and we implemented the Iot solution with Red Ravens real time digital monitoring capabilities. We've empowered this customer six active approach to diagnose and <unk>.
<unk> equipment failure.
Going forward. Our plan is to continue to focus on instruments, our existing installed base as well as new equipment with the significantly growing this recurring revenue stream and providing additional pull through aftermarket opportunities.
While we are enthusiastic about the opportunities available from our diversification de carbonization Digitization strategy.
Serves responsibility to ESG truly embedded in all aspects of our business.
On June 30, we released.
Our 2012.
Rental social and governance report outlining our ongoing commitment to create extraordinary full solutions that make the world better for everyone.
We believe this focus will not only enhance our own ESG efforts, but will also serve to play a critical role in supporting our customers build a better tomorrow.
I encourage everyone to review the entire report available on our website, but I'm, particularly pleased to highlight our strong safety performance. Our continued progress to achieve our 2030 carbon emissions reductions goal.
The commitments, we've made to the communities we serve through closer cares, where we supported over 150 charitable organizations last year.
Our ESG progress was recognized last year by Forbes magazine as one of the world's top female friendly companies and Newsweek magazine ranked closer to as one of America's most responsible companies for the third consecutive year.
We are proud of our achievements in the third party recognition, but we're really only at the beginning of our ESG journey closer we'll continue to prioritize ESG and make additional progress in the years to come.
In closing I am confident as opposed servers, making progress I remain impressed by our associates passion commitment and expertise with.
With the solid progress we've made in the second quarter I'm convinced that we're doing the right things to work through the challenging environment and position us for growth ahead.
As we look to the remainder of the year I am very encouraged by the health of our end markets and our ability to capitalize on these opportunities through consistent execution execution and customer focus.
We expect further and converting our strong $2 $3 billion backlog, improving our operational execution and advancing our growth strategy to position closer to exit 2022 with significant momentum.
Together, we believe this focus will enable full serve to deliver solid long term value for our associates, our customers and our shareholders.
Operator, this concludes our prepared remarks, and we'd now like to open up to questions.
Thank you if you would like to ask a question. Please signal by pressing star one on your telephone keypad.
If you were using a speaker phone. Please make sure. Your mute function is turned off to allow your signal to equipment again press star one to ask a question.
We will take our first question from Joe Giordano with Cowen.
Hey, guys. Thanks for taking my question.
Good morning, Joe.
Hey can you maybe try to scale some of the.
Opportunity in Europe .
With nuclear nuclear and gas being.
Considered green now and the size of LNG like if you were to take all of that what is that now for you guys and what can that potentially be overlay quinoa.
The retooling of the European power situation.
Sure obviously the situation in Europe is significant as they get less and less natural gas from Russia.
So what we're seeing is the renewed interest in both nuclear LNG natural gas and other forms of energy are these are all traditional market full service place for decades.
Got it incredibly strong.
In Europe , we have great capabilities and great products for those markets and so we're really just about what's happening there and our ability to help Europe secure energy for the future.
Just as a reference to your year to date in nuclear where we booked about $140 million or substantially more than we've seen over the last couple of years.
And that funnel continues.
So we are we are positioned very nicely for nuclear will be significant spending there and we're already seeing a lot of that both on some of the expense side, but also on just extending the life of those assets and so we believe it's.
An area of growth for us.
As the forward.
The coming quarters.
We'll continue and ourselves and from successor.
I noticed in one of the slides when you were just going through the financials.
FCB the gross margin was the same in SG&A was significantly less.
FCB, so what's like the natural gap, there and how should we think about that going forward.
So generally if we think about if we think about SG&A between the two segments at CD normally and we would expect to have a little bit of a lower run rate from an SG&A perspective, and in part because of how we allocate R&D costs between between the platforms, but I think thats to chip.
That you would expect to see continue going forward.
So the gap that we saw this quarter was like a normal debt that mag.
Magnitude of gap is pretty normal for what you would expect.
I Wouldnt I don't think it with and how would it be in terms of what we saw this quarter or what we would expect going forward.
Okay, Great and then just lastly, if you can maybe just comment on your working capital outlook for the rest of the year I know you will deliver more cash in the second half like you always do but just your view on some of the key working capital accounts. Thanks.
Sure So I think.
I would start with inventory and as we think about pushing.
Working capital performance in 2022, we are we are not focused in driving down the inventory.
Below where we're at today, we recognize that there are some investments that we need to make.
With respect to inventory coming into our plants in order to stabilize the supply chain and in addition to that as these large bookings coming in.
Yes.
An archive assets moving forward, so where we need to continue push from a working capital perspective is with respect to collections.
And obviously our own pace.
And we will continue to do that.
Receivables as an area, where we put quite a bit of focus as a company and through the transfer and <unk>.
<unk> and we will continue to work to drive and to drive collections improvement frankly, the mix that we see with strong with strong MRO sales should help us help us do that.
And from an APM vendor perspective, we will continue to work with our vendors and push on working capital, but overall.
We're at 29, 9% fifth quarter, and Scott and I continue to have a goal of driving primary working capital as a percentage.
As a percentage of sales down to the mid <unk> and I.
I would anticipate that this year any improvement that we see over where we're at in the second quarter of this year will be relatively modest.
Thank you.
And we will take our next question from Nathan Jones with Stifel.
Good morning, everyone.
Maybe just following up on the working capital question.
Typically youre going to consume a little bit more working capital when the business is in growth mode, which clearly with the order rates growing backlog growing it's growing debate is that target a little bit more difficult to achieve in 2023 or 2024 as a result of.
Potentially needing to support the growth in the business with working capital.
So I think two things will will incur over time certainly as the business grows we see we see pressure.
On our receivables perspective from an inventory perspective, and that would include obviously our contract assets and liabilities. What I will say I think is going to be a tailwind going forward as as we work through the supply chain.
And fix challenges many of which are causing us to carry inventory at levels above where we would traditionally be at I think as we think about this in terms of Ah.
About 2023, and 2020 outlook, Frank that we will continue to moderate and be able to carry inventory.
At levels that are better at safety stocks that are that are more normal for the industry. So although I'd like the challenge today I think as we move move forward 12 months and 24 months it actually becomes an opportunity for us.
Great.
I wanted to ask a follow up on I think you called it the Decarbonization project funnel I think it was like $675 million versus low four hundreds at the end of the year.
Can you give us some more color around that project funnel kind of how quickly to these projects.
How quickly do they get awarded what kind of win rate do you have on the funnel that you're tracking.
Just some more details you can give us around that.
Sure Yeah. So the deep organization side is something we're really excited about what we're seeing is and I.
During the prepared remarks is that across all of the in market everyone is doing something to reduce their cotwo emissions and so we're seeing that either with energy reduction right. So the amount of energy that's needed to run their asset we're seeing it in electrification of the asset we're seeing it in.
Carbon capture and sequestration and then we're also seeing lots of offers.
Around the biodiesel side or the bio bio.
<unk> conversions.
And then as we go.
Forward, we're seeing that now in Green energy right, so whether thats concentrated solar power of the hydrogen award that I mentioned on our call.
But what we're seeing is like this is this is happening in our traditional markets and it's also happening with the new energy sources.
So Korea is growing faster than anything that we have.
Any of our markets and I would say that continues to grow as we move forward throughout the next probably the next couple of years.
We are well positioned to that our offering both in pumps valves and seals is works for a lot of the different applications.
We're continuing to invest our new product development in our R&D to make sure that we're well positioned for <unk>.
Success as these markets.
And move more and more.
Move forward.
Are your win rates on those kinds of projects any difference to your traditional kind of projects that you Trust.
Yes, I think they are slightly higher than what we would say is our traditional and so a lot of these projects were working directly with the end user some of them are through EPC, but when we can work directly with an end user demonstrate our ability to help them in the front end design in the engineered solutions then we have got a much better chance.
So success, yes, I Wouldnt say were double the win rate of our normal markets, but we're certainly doing a better job than than just in the traditional markets there.
Great. Thanks for taking my questions.
Thank you our next question from Damian Cross.
Hi, good morning, everyone.
Good morning, Hey, Jamie.
So we should go ahead and model to 60% incremental margin in perpetuity that thing seem reasonable.
Yeah.
Yeah.
I wouldn't recommend that.
But we do expect to continue to see incremental improvements in our businesses.
Sure Jeremy.
Yeah.
So maybe you could just talk a little bit more about the backlog conversion and how thats trending I think last quarter. It maybe through a route through around a 46% number.
What are you assuming for the rest of the year and I guess.
We think about the 12% to 14% margin.
Where you plan to exit is that basically assume youre kind of back to normal on that conversion ratio.
No.
As we look at conversion rates.
And we saw some modest improvements in our valve portfolio in terms of conversion rates moving from the first quarter to the second quarter, but really the improvement that we saw between Q1 and Q2.
Was some reduction in some of those frictional costs and improved marginality.
In.
In the in the products that we shipped during during the quarter. So as we move forward in <unk>.
In the year, we're not anticipating a resumption of sort of that 46% average average conversion rate.
Our backlog moving forward that the fundamentals in the supply chain and our markets are just are just not there for the remainder of the year, but as we think about that fourth quarter quarter exit rate.
One I would start by by commenting that the fourth quarter is traditionally closer to the biggest quarter of the year from a revenue conversion from an operating income and cash flow generation standpoint.
And the operational bottlenecks that we've seen year to date.
Macerated that trend so the fourth quarter is going to be Bang. In fact, we would think that the fourth quarter could produce roughly half of our full year adjusted EPS and that's in part because of a pretty weak Q1.
And as we think about the third quarter realized late in the second quarter in the third quarter oftentimes look pretty similar for flow serve and while this year.
Would expect incremental revenue and earnings improvement based on the size of the backlog south and not fairly convinced.
Our ability to fully capitalize on that backlog is somewhat limited by summer holidays in the northern hemisphere and so by contrast in Q4 not only do we have the backlog in place that can do within our capabilities to manage them.
Our improving the pricing increases will be fully embedded and in our SG&A, which we've done a pretty nice job controlling we'll be able to be fully leverage in the quarter.
Got it that's quite helpful.
And then Scott you.
You spoke pretty favorably earlier about LNG and some of the demand youre seeing there.
Just curious how competitive you are finding these LNG opportunities and.
How are you thinking about the profitability there as you're bidding on these projects.
And really maybe any additional color you can share on the types of when you are saying.
Sure. So we're definitely doing well in the LNG space and so we did approximately $30 million in the quarter on LNG Awards.
After the $46 million, we did in Q1 and so we are we believe both on the pump side and the outside and our mechanical seals, we've got a great offering for LNG and so work.
To be very bullish on the outlook here and our ability to win win awards came from a margin or a pricing perspective.
So a little bit favorable to the overall mix for us just because there is less people that can play in the cryogenic side to have the technology that we have and so we like this market a lot and we see significantly strong growth over the next 12 months in fact, our opportunity funnel for the year is over $400 million.
Next 12 months.
Great Best of luck.
Well.
Go to our next question from Andy Kaplowitz with Citigroup.
Good morning, everyone.
Hey, Andy.
Scott So orders have been relatively consistent over the last couple of quarters, both an aftermarket and OE, but you did mentioned some projects are moving to Q3 from Q2 do you still see a potential positive impact from large projects coming over the next couple of quarters and I know you've talked about some risk to the strength in Durham.
<unk> the cycle from inflation on door potential recession. So what are your customers, saying to you at this point in the middle of the year.
Sure Yes, the large projects are always interesting because you can it's very difficult to predict timing on a quarterly basis, but what we've seen is over the last two years 2020 in 2020. One those projects were basically put on hold and we're just now seeing a lot of those start to the system.
Get funded.
While slightly lower in Q2 large projects then Q1, we still have significant visibility to large projects. In fact, our project funnel is up 13% since the beginning of the year and we continue to be very optimistic in our ability to get projects in the second half of the year.
As we've.
We've talked about in the first quarter, we had four large awards that were over $20 million.
Here too we had no awards over $20 million, but we had 50 rewards from that 5% to $20 million.
We saw a couple that we expected to book in Q2 have now slid into Q3, which are already booked in July and so yes, I would say certainly for the back half of the year, we have a lot of visibility and we are well positioned for success in winning these large projects.
And then I'd say.
And then as we kind of go forward. This is where we've got to talk about recession, and inflation and everything else and the dynamics, but I would say today I still feel reasonably confident that these large projects continue putting 23 and 2024 when he goes kind of what I said in the prepared remarks on the macro environment.
Right.
There is a need for energy independence, and so youre going to get significant investment in oil and gas and LNG in a nuclear they know that.
There is a continued desire for the de carbonization and the Sidoti reduction and so theres going to be significant investment in the curve sure efficient.
The biofuels recyclable plastics and the hydrogen and so I just think that the net net.
We still think that Theres, a positive outlook for projects moving forward and then I had a bunch of customer conversations in the second quarter and nobody was talking about those projects moving out or being delayed they were very confident in the continued movement in progression of funding and ultimately execution of these laws.
Projects.
That's very helpful. Scott and then maybe could you give us a little more color into what youre seeing on price cost I know you mentioned the two big price increases this year, but are you seeing any improvement as you bid on these larger projects yet or is there still a bit of slack in the system. So you kind of have to wait a little bit to see more significant improvement.
Yeah, I'd say, we talked about this in the first quarter and I would say there really hasn't been a significant change and so the larger projects.
More competition absorption rates aren't where they need to be fully within our peers.
So the pricing is challenged on the larger projects.
Feel good about our margin and backlog continuing to move up.
Feel good that the press release in the first quarter is making its way through the system in the second quarter and the end of the year and then the price increase that we did which was an 11% we feel confident that thats going to start to show up in the back half of the year and the price increases as you know Andy are really adar assemble to order.
Configure to order work the engineered to order work is mostly on a cost plus basis, but I'll tell you. Our team is incredibly focused as our bookings have improved as we've got better visibility to our capacity getting filled up.
Certainly moving up that expectation of margin and backlog and so I'd say, we're the perfect environment on pricing, yet, but we are starting to see some improvement.
Yes.
Just the price of steel.
We feel good that matching material prices inflation all of the things that we would look at from a price cost standpoint, and we feel like we're.
At least neutral or growing ahead of it.
We exited the year.
The areas that we still have to work on.
And you talked about in her script per script and that's the.
Costs were substantially lower in Q2 than in Q1, and the absorption side as well.
As we start to fill up and as we start to continue the mineralized that frictional costs, then we start to see our margins progress up throughout the year.
I appreciate all the color.
Well go to our next question from.
Dean Dray with RBC capital markets.
Thank you and good morning, everyone.
Can we circle back on China, because it.
That was an area of angst last quarter and the Debottlenecking that you would hope would happen seems to be going through just kind of some additional color.
Is it back to normal how soon is to come back to normal.
Any other kind of repercussion.
Sure and just as background for everyone. We do.
Our presence in China with both our pumps that are valves for these vessels.
Sue Joe and then our supply chain.
<unk> leverage to China, as well and so as China gets locked down and has problems.
It does have a significant effect on closer.
What we saw of the second quarter was was an easing in the Lockdowns are really at the very end of the second quarter.
And so that was a positive development as it is and kind of move forward, we expect that to continue to be stable.
We expect us to continue to progress there. So I would say right now we're not operating at 100%, but were operating more in that kind of 70% to 90% depending on the weekend and the different situations.
Generally the supply chain there is not like us is not fully back to a 100% normal, but it's substantially better than what we saw in Q2 and the first two months of Q2, and I would anticipate that Q3, and Q4 will be reasonably stable but.
It's really hard to predict that and I certainly got it.
That money on the on the stability of China right now.
Understood completely and agree.
And then follow up question I might have missed this data point, but if you step back in and categorize your total orders this quarter within the.
The context of three D.
What percent of the orders would fall within the diversified D carb and digital.
Yes, so just as a reminder, the <unk> bookings are really that diversifies to decarbonize the digital yes.
Yes.
It is stuff that we would have gotten additional.
Ali.
And so we got to be a little bit careful how we think about it but to answer your question directly it's roughly a third or closer to a quarter of our total bookings would fall in those categories.
And so we're very obviously, we are very focused on that.
It was 275 hours of bookings in <unk>.
Second quarter alone and then what I'd say is as we track projects about two thirds of overall project funnel.
Project bookings were in that category and so our organization is very much leaning in on this strategy our incentive plans are aligned to grow in these areas.
And then like I said in the prepared remarks as I talk to our customers. We're getting very good feedback that we're on the right.
That will drive long term growth in for a full serve and this doesn't mean, we're walking away from our core markets. In fact, we are very encouraged of that.
Gas market, the power market and our other traditional markets.
At the same time, though we believe that this gives us an accelerator as we move forward.
Good and just related to this on the diversified manner.
Mandate.
When you go into an under penetrated.
Sector, you said water and chemicals.
Do you need to compete more on price to build out our presence and our market share there or is it so might that be lower margin either initially or.
Does it not play out that way.
Yeah I think.
So I wouldn't say, it's not the same for each product each market yes.
One example, uttered offering we've had a product that.
Quickly has done really really well in water, we kind of walked away from that kind of 10 years ago and it didn't really invest in the product line and didn't invest in the channel in the market.
We did assume that product through our design to value Center, we were able to take out roughly 20% to 30% of the costs, we were able to reconfigure the product and simplify that offering into something that took out part numbers improved our ability to manufacture took out space and weight and then drove the costs down by 20%, 30% and so.
So in that specific example, our margins are actually increasing in our ability to compete is substantially better but there are times that when we're looking at something very specifically and we've got to make some compromises on pricing to get in there and start to build a track record of success that were used as a kit and talk to our customers, but I always.
Just say no.
I don't think were compromising on margins versus <unk> category.
That's certainly not the communication and discussion with our teams.
It's hard to say just because we do it with a broad product line to say one versus the other but I would say overall I wouldn't expect margin deterioration and implement our diversification strategy.
Thank you.
We will take our next question from John Walsh with Credit Suisse.
Hi, good morning, everyone.
Hi, good morning.
Wanted to circle back to the Q4 exit rate to 12% to 14%.
Wondering if we could talk about the buckets that drive that and maybe put any numbers around it meaning it sounds like you've got visibility with the margin in the backlog.
Maybe OE aftermarket mix, what that's doing in Q4.
Just any of those big buckets to kind of give people more confidence that that's actually the right exit rate.
So I'll start by saying that there is a large component of that exit rate.
And then by by volume.
And so as we think about as we think about that does a number of things.
Obviously, it gives us more leverage over over our fixed costs with at a site level.
On an FTE perspective, we're not anticipating major increases in <unk>.
Over the year and the absorption bucket talk about real.
In two ways.
I mean, because our OE.
Is it is filling up and we now have work and particularly our large engineered to order shop. It's also coming as we get more key around the supply chain and keep in mind when I talk about certainty that's not net early improvement Isabel.
It's about the stability of the supply chain.
Then.
The material that we need on the shop floor.
In order to perhaps work through and absorb the hours.
Our workforce.
At the plant level.
So really volume is going to be a significant.
Of that improvement at the 12% to 14% as we think about other things that we included.
A frictional costs.
Logistics has been another big story that at least there and as we talked about in the first quarter of the year.
<unk>.
Literally everything.
Being expedited.
Everything that we were making pretty broad assumptions about what were the materials that needed to be expedited as we transition from Q.
Into Q2, and we've seen.
As being more to put around.
Guiding materials, we've also seen.
Better information flow the site level to allow us to make decisions about what is the way that we're transporting goods stuff plant site can we use the ocean freight and steady heavy way there as an example, which leads to a significant decline in cost.
Are we using our contracted route.
Yes.
Our road shipments and that allows us to.
So we saw some improvement in logistics cost.
And in Q2, and particularly in the valve space, which we would expect to continue over the course of the year, but it would be but that's going to be a benefit but it's working for go quarter on quarter, because those costs are actually that is embedded in our inventory.
We think about that.
And around the quarter perfect.
It's volume and which will be less constrained in the fourth quarter and is not yet frankly on.
And that is as it is traditionally on book to ship the backlog in place and then that improvement that we're seeing.
And finally, those frictional costs around logistics and other areas of the supply chain.
Great. Thank you and then maybe just a follow up around price cost.
You've obviously done a lot of pricing initiatives over the last several years.
Just thinking about if we snap the line on kind of certain commodity inputs.
You think youll be able to keep price.
You know I don't know how much of this was kind of surcharged versus you actually pricing for the value we're delivering to customers.
Sure we did.
Charge examples primarily on fuel costs, but.
For US we went hard on just doing an overall price increase and so again, we had 5% at the beginning of the year, 11% implemented in May assets, and we believe that if we do it.
Direct cost of products, so that would be our materials are labor, we feel really good about where we are on price cost.
Experience this year and in the first quarter, where those costs and the under absorption.
Products through our facilities.
And so those are the areas that we're working on I think Amy described both of those in detail and how they get Q3 and Q4.
So I would say.
Right. Now then we feel we're in a pretty reasonable position on price cost and that will translate to higher returns.
And the balance of the year.
One thing just to note with our price increases so I would say throughout 2021, and our first price increase.
2022, those where it's somewhat in catch up price increases in order to get us back to where we needed to be from a price cost perspective, I think the may price increase that we put in place more anticipatory in terms of what we saw happening.
For the year. So I think we're now at a good.
As well.
Eric.
What has happened, but what we see will be happening.
In our in our major spend categories.
Great. Thank you.
Thank you our next question from Josh.
Penske with.
Morgan Stanley .
Hi, good morning, Thanks for fitting me in here.
Yes.
Scott a question for you on.
Or I guess in your Scott whoever wants to take it on.
Fourth quarter is is trying to tell us about the backlog or maybe the margin profile here over the medium term I guess, there hasnt been what you would call a normal year in some time, but.
<unk> margins tend to be sort of two to five points above maybe what the following year is taking an average with a pretty pretty wide range.
Is that sort of a fair starting point I mean, I know on one hand, you have had a lot of volatility, but we're also kind of in year, four or five of closer to <unk>.
And an awful lot of tailwind starting to pop up from from some of these new markets, particularly around <unk>. So just wondering how kind of fourth quarter is pointing us into the early read on on future margins.
Yes, it's a really good question, let me start and then I'll hand, it over to Amy to provide some more details on our progression from kind of where we are today and into the fourth quarter.
Just start by saying that the environment that we're operating in is just unbelievably challenging and as you can see from our results over the last couple of quarters is very difficult to predict what we're what we're what we're seeing and then how do we executed that.
I would say is that we're seeing signs of stability.
Externally and we're seeing progress within our internal operations and so if that stability continues I'm confident the actions that we're taking the things that we started way back in closer to follow all of those things start to come through the system, but again, it's just such a volatile environment you can see that in our numbers you can see it with other.
Manufacturers, it's a difficult time, but we're confident we're doing the right things and we're very confident that we're going to be able to progress, but Amy why don't you walk through some of the details on Q3, and then into Q4 sure. So.
<unk>.
Again with with.
With our progression during the year I think we need a couple of things to happen to continue to see the progress that we want to see that ultimately results in that exit rate. So we need materials in our shop floor, and we need we need the hours available from from our Labor force in order in order to push that product through and we really see.
The fourth quarter of this year as being as being our opportunity to kind of catch up on those longer lead times that we've seen from a supply chain perspective, and then also deliver in the way that we've traditionally delivered.
In the fourth quarter and at flow serve and Youre, absolutely right that as we look across really.
Really the last three years, whether it'd be 2000, 22021, and now 2022 with the unique challenges that we've seen in each of the years.
Haven't necessarily played out and as normal quarters, but I think as you hear us talk about that exit rate for 2022, we're talking about it as a momentum building quarter and that frankly as we go into it in the end of 2023 without giving guidance. We think we're going to have a strong backlog.
And so we start to return more to you.
More to a traditional year for flow thorough a in terms of what that looks like and so that doesn't necessarily mean that it doesn't mean that our exit rate of Q4 will be will be our margin rate in Q1.
But it doesn't mean that we're going to try and build off of that exit rate and move towards expanding margins over the course of 2023, knowing that what we delivered in the fourth quarter kind of reset the baseline of where we want to go where.
Where we want to go in 2023.
It's Greg.
Good luck.
Thank you.
And as there are no further questions. This will conclude today's call. Thank you for your participation you may now disconnect.
Great. Thank you.
Yeah.
Okay.