Earnings Call. My name is Jenny, and I'll be your operator for today's call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. Please note that this conference is being recorded.
I will now turn the call over to Jay Roush, Vice President of Investor Relations and Treasurer. You may begin.
Thank you, Jenny, and good morning, everyone. We appreciate you participating in our conference call today to discuss Flowserve's 2019 Q3 financial results. Joining me this morning are Scott Rowe, Flowserve's President and Chief Executive Officer and Lee Eckert, Senior Vice President and Chief Financial Officer. Following our prepared comments, we will open the call for questions. And as a reminder, this event is being webcast and an audio replay will be available.
Please also note that our earnings materials do and this call will include non GAAP measures and contain forward looking statements. These statements are based upon forecasts, expectations and other information available to management as of October 31, 2019, and they involve risks and uncertainties, many of which are beyond the company's control. We encourage you to fully review our Safe Harbor disclosures as well as the reconciliation of our non GAAP measures to our reported results, both of which are included in our press release and earnings presentation and are also available on our website at flowserve.com in the Investor Relations section. I would now like to turn the call over to Scott Rowe, Flowserve's President and Chief Executive Officer for his prepared comments.
Great. Thanks, Jay, and good morning, everyone. We appreciate you joining our call today. Flowserve again delivered good quarterly results, while continuing to make progress on our Flowserve 2.0 transformation journey. As we approach the halfway point of this strategic program, I am encouraged by the increasing momentum we are seeing in our operations and in our financial results.
Additionally, our employees engagement and enthusiasm to drive sustainable changes is apparent at all levels of our organization. Ultimately, we expect to build an organization capable of performing at a high level in any business environment. We are well on the way to making this Let's turn to the financial results for the Q3. We executed well delivering 4.6% revenue growth, improvements in adjusted gross and operating margins of 60 and 100 basis points respectively and adjusted EPS of $0.59 a 20% increase over the prior year. Flowserve's reported EPS was $0.52 up 0.31 dollars year over year and representing nearly 90% of our adjusted earnings.
This reflects a significant improvement in our quality of earnings. As a result of our strong performance thus far in 2019, we increased the lower end of our adjusted EPS guidance range to $2.15 while keeping the upper end in place at $2.20 We feel confident in our ability to deliver the full year $120,000,000 more in year to date free cash flow than last year. Better operating income, reduced realignment spending, improved working capital management and disciplined capital spending all contributed to the cash flow growth. Moving now to our segments. The operational improvements in FPD continue to flow through the segment's financial performance.
In the 3rd quarter, FPD grew revenue by 5.4% year over year and delivered a 24% increase in adjusted operating income. Adjusted gross and operating margins both improved 200 basis points. While this performance included a 2% aftermarket mix shift benefit, it was primarily driven by our ongoing improvement initiatives, including continued progress in legacy IPD facilities, ongoing value engineering in our product portfolio, improved planning processes, better productivity and inventory management as well as initiatives to drive lean manufacturing deeper into our operating footprint. FPD's 3rd quarter bookings increased 6.3% year over year despite 3 30 basis points of currency and divestiture headwinds. Turning now to FCD.
The 3rd quarter largely played out as expected in how we communicated on our Q2 call. FCD continues to be impacted by the slowdown occurring in the North American short cycle MRO business and the distributor destocking that began earlier in the year. 3rd quarter revenues were essentially flat sequentially, and I am pleased that FCD's adjusted gross and operating margins improved by roughly 150 basis points compared to the 2nd quarter, considering the mix dynamics were largely the same. On a year over year constant currency basis, FCD grew its top line by 4.9%. However, a higher percentage of revenues were derived from larger original equipment projects as opposed to higher margin short cycle MRO work.
FCD margins were negatively impacted by this mix shift on a year over year comparison as adjusted gross margins declined by 300 basis points. With more focus on controlling our costs, we were able to limit the impact on operating margins to a decline of 250 basis points compared to 2018 Q3. The continued slowdown in the North American MRO and distribution business also had an impact on FCD's 3rd quarter bookings. Bookings in the quarter decreased 2% of negative currency impact. The end markets that typically have the highest exposure to this type of work saw the biggest impact, including a 21% decrease in general industries, a 10% decline in chemical and a 7% decrease in oil and gas.
Partially offsetting the declines was a 61% increase in power bookings year over year. We expect the North American MRO bookings to recover in time, but we have yet to see a positive inflection for the FCD business. Turning now to our consolidated bookings and end markets. 3rd quarter bookings increased 1.3% to $1,000,000,000 or 4.1 percent excluding the impact of currency and divestitures and represents a book to bill of 1.03. This marks the 6th consecutive quarter, which we've delivered bookings over $1,000,000,000 combined with year over year bookings growth.
This level of performance continues to be driven by our growth oriented transformation initiatives and greater collaboration across our pump, valve and seal products as we leverage the power of the pure play. On a year over year basis, nearly half of our bookings have come from customers who purchase more than 1 Flowserve offering. Our year over year bookings growth in the Q3 was driven by smaller projects and upgrade work. In the quarter, Flowserve booked 2 projects above $15,000,000 in size. There are 4 of these larger awards in last year's numbers.
We do expect the progression of energy infrastructure projects to continue. However, there is more uncertainty at the macro level than earlier in the year. Refining, LNG and chemical end markets remain encouraging as large projects and EPC backlogs continue to move toward equipment order placement. The current macro environment makes the timing of large projects awards more difficult to forecast. Whether it's the commodity pricing, trade disputes, Brexit or issues in the Middle East, the increased uncertainty in this current geopolitical situation has driven delays in capital spending.
The good news is we have not seen nor do we expect significant project cancellations. We believe the opportunity set of global projects will move forward, especially for refineries and chemical plants as they are driven by increased global demand. Our original equipment bookings have grown by 13% year to date. We are capturing our fair share of the opportunities that are out there and our teams are focused on building a quality backlog to drive margin growth in the markets, regions and with the customer base we pursue. Turning to aftermarket.
3rd quarter bookings of nearly $500,000,000 were essentially flat versus prior year on a constant currency basis. Our commercial program, which is a critical component of the Flowserve 2.0 growth initiative, helped offset the short cycle market slowdown in North America as we continue to increase our share of our customers' maintenance spend. We fully expect to drive growth in our aftermarket franchise through the combination of our growing installed base, customers' increased focus on efficiency, regulatory changes and execution of our proven growth initiatives. From a served end market perspective and starting with our largest market, oil and gas. 3rd quarter bookings decreased 6% year over year, including 2% negative currency impact, driven by mid single digit declines in both FPD and FCD.
The 2018 compare period was challenging as last year's Q3 provided our highest level of oil and gas bookings of the year. Oil and gas markets remain active, particularly in the Middle East and Asia Pacific with a number of $5,000,000 to $10,000,000 down and upstream awards across both segments, driven by refinery upgrades and clean fuel projects, including ongoing work related to IMO 2020. North American oil and gas remains more challenged due initially to upstream spending discipline, which has impacted the region's MRO activity and distributor stocking orders. We did, however, receive another North American pipeline award this quarter, thanks to our strike zone efforts. Our constant currency chemicals bookings increased 11% in the quarter, driven by FPD's 24% growth, partially offset by FCD's 10% decline.
The quarter included a small project award to FPD in the Gulf Coast. See a strong pipeline for near term opportunities in the Gulf Coast region and expect similar opportunities to come in Asia and the Middle East, driven by a forecasted global demand growth. Our power markets increased 45%, primarily due to the lower 2018 compare, which was our lowest power bookings total in over 5 years. While challenges in our power markets continue, we are pleased with 2 awards in the $5,000,000 range, concentrated solar power market with a flow of power of a pure play differentiating offering of pumps, valves and seals provides opportunities in a growing market. We continue to support our global fossil and nuclear installed base with maintenance, upgrades and life extensions and look to participate in fuel switching opportunities in North America and Europe as well as a limited new build project set primarily in Asia.
3rd quarter bookings in general industries declined 1% year over year, including 2.5% of currency headwinds. FCD's 21% decline was largely offset by FPD's 11% growth. FPD continues build its global distribution channel and the 3rd quarter included solid growth in Europe, Middle East and African markets. As many of you know, about 40% of FCD's sales go through the distribution channel and much of that is categorized in general industries. So the distributor destocking activity we've experienced was the primary cause of the decline in general industry category.
In addition, FCD's percentage decline was also impacted by a large $6,000,000 marine project that was booked last year that did not reoccur. Lastly, representing our smallest market, water bookings increased 7% in the 3rd quarter, including 2 de salination awards, which totaled over $20,000,000 combined, and 2 awards for Water Management North America, each in the $5,000,000 range. Turning now to bookings by geography. The strength in the Middle East and African markets continued with 38% growth in the 3rd quarter and is up over 40% for the year, driven by significant refining and chemical investment. North America and Asia Pacific both delivered low single digit bookings growth, while Latin America was flat.
Europe remains our most challenged region overall with bookings down 19% year over year. I'll now turn the call over to Lee to cover our financial results in greater detail, and then I
will return for some closing remarks before we open the call to Q and A. Lee? Thanks, Scott, and good morning, everyone. Our financial results for the Q3 reflect the progress we are making in our Flowserve 2.0 transformation journey. Adjusted earnings per share of $0.59 increased 20% year over year and about 10% sequentially.
On a year to date basis, our adjusted earnings per share has increased approximately 32% to $1.54 per share. Our reported EPS for the quarter was $0.52 which included $0.06 of realignment and transformation charges and $0.01 of negative below the line currency impacts. Looking at the 1st 9 months of 2019, our reported EPS of $1.40 increased $0.97 or over 3x the EPS from last year, and it represents over 90% of our adjusted 2019 EPS.
On a year to date basis,
we have reduced after tax adjusted items by $78,000,000 versus prior year. This reduction demonstrates our continued focus on improving the quality of our earnings. Revenues in the 3rd quarter were $997,000,000 an increase of 4.6% versus the prior year. Excluding the impact of foreign exchange and divestiture headwinds, organic revenues grew 7.4% year over year. 3rd quarter aftermarket sales increased 6.7 percent or 9.4% on a constant currency basis to $488,000,000 and represented 49% of our total sales, essentially the same percentage as the prior year.
Turning to our margins. 3rd quarter adjusted gross margin of 33.8 percent increased 60 basis points year over year and 130 basis points sequentially. SPD's 200 basis point improvement year over year was a key driver as we continue to deliver operational and productivity improvements, including the further leveraging the combination of our pumps business that we implemented earlier this year. Partially offsetting SPD's strong performance was decline in FCD's adjusted gross margin year over year to 32.8%. As Scott discussed, FCD has faced market and mix headwinds for much of this year consisting of strong growth and larger project oriented work offsetting a cyclical decline in MRO activity.
FCD, however, did improve its adjusted gross margin sequentially by 150 basis points in the 3rd quarter on a modest sequential revenue decrease. On a reported basis, Flowserve's gross margins increased 110 basis points to 33.5 percent driven by essentially the same factors I discussed as well as approximately $5,000,000 of lower realignment expense in 2019. We remain focused on managing our cost structure and are pleased that our Q3 adjusted SG and A was essentially flat with prior year at approximately $220,000,000 even as we delivered bookings and revenues growth in the quarter. As a percentage of sales, adjusted SG and A decreased 50 basis points to 22.1%. On a reported basis, 3rd quarter SG and A decreased approximately $16,000,000 driven primarily by the lower adjusted items versus prior year.
At the operating level, our adjusted operating margins improved 100 basis points to 12% as a result of our strong adjusted gross margins and tight cost management. FPD's 13% adjusted operating margin increased 200 basis points year over year, which was partially offset by FCD's 250 basis point decrease. On a sequential basis, both segments adjusted operating margins improved, including FCDs by 150 basis points. The reported operating margin increased 4.50 basis points year over year, which benefited from continued operating improvements and sales leverage as well as approximately $33,000,000 reduction in adjusted items. Our adjusted tax rate was 25.9 percent at the low end of our prior full year tax rate guidance of 26% to 28%.
Considering our adjusted tax rate through 9 months was 25.8%, we revised our full year tax guidance yesterday to a new range of 25% to 27%. Turning to cash. Operating cash flows through the 1st 9 months of 2019 increased $118,000,000 versus prior year, driven by our earnings growth as well as improved working capital management. While we've demonstrated incremental progress in our working capital management, we expect to deliver more improvement over time and are confident in our ability to achieve our goals. A key enabler to truly embedding sustainable systemic improvement within our inventory and order cash processes, we'll be implementing enterprise wide systems and processes.
It is a journey, but I'm pleased with the results we've delivered thus far. At September 30, our cash balance was approximately $550,000,000 or roughly $17,000,000 higher than last year's Q3 balance. This year over year improvement comes after approximately $140,000,000 of certain third quarter cash expenditures. For example, during the quarter, we retired $75,000,000 of debt, returned about $30,000,000 of capital to shareholders through dividends and share repurchases, invested $19,000,000 in capital expenditures and contributed $14,000,000 to our U. S.
Pension plan. Turning to our outlook for the remainder of the year. We are pleased with our strong results for the 1st 9 months of the year and expect solid performance again in the 2019 Q4. As such, we increased the low end of our full year adjusted EPS target range by $0.10 and now expect between $2.15 $2.20 per share for 2019. This range excludes approximately 2019 realignment and transformation expense of approximately $50,000,000 as well as global aligned foreign currency effects and the impact of potential other discrete items, which may occur.
We also increased our reported EPS range between $1.85 $1.90 dollars per share. We expect these results based upon full year revenue growth of approximately 2.5% to 3.5%, including increased full year headwinds now expected from currency of approximately 2.5% and roughly 0.5% due to last year's business divestitures. Turning to our expected cash usage in the 4th quarter. Following year to date debt payments of 105 dollars and pension contributions of $20,000,000 during the 1st 9 months, we have already met our commitment in these areas and do not expect any further payments this year. We do anticipate returning approximately $35,000,000 to shareholders during the Q4 through dividends and share repurchases.
And we'll continue to invest in our business through capital expenditures during the Q4, although we have reduced our full year expected spend to $75,000,000 to $85,000,000 as we remain disciplined in our approach. Now let me turn it back to Scott for his closing remarks.
Thanks, Lee. I'd like to wrap up by spending a few minutes on our outlook and the progress of our transformation efforts. As our guidance indicates, we expect to finish 2019 on a strong note. We are confident in our ability to deliver to the new guidance range, which represents adjusted EPS growth of over 20% year over year and nearly 60% better than 2017, my first year at Flowserve. Year end 2019 will also mark the halfway point of our multiyear Flowserve 2.0 transformation journey.
I am extremely encouraged by the progress we have made to date, but even more optimistic about the opportunities that remain in front of us. We have made significant investments to drive cultural and enterprise changes, and our employees have truly risen to the challenge, embraced the changes, and they continue to drive results. I am impressed and encouraged by the level of excitement that we are making within our global operations. To maintain the momentum, we will continue to have a dedicated transformation team throughout 2020. I expect significant progress in 2020 with our operational initiatives, while continuing to focus on growing the company.
We are laying the manufacturing foundation to significantly improve our deliverability of products and dramatically reduce our cost to produce. We are well on the way to fully transforming Flowserve, and I look forward to continuing to deliver increased value to our employees, our customers and our shareholders as we continue the transformation journey. Operator, we have now concluded our prepared comments. And we'd now like to open the call
to
And our first question comes from Joe Giordano.
Hey guys, good morning.
Hey, good morning, Jeff.
Hey, so good quarter and I see the stock down more than the industrial sector. So I'm assuming that a lot of that has to do with really negative short cycle comments we've heard from other companies over the last couple of days today as well. But our sense is that there's just this there's this belief that orders next year are faced this real cliff. So I know you guys have been very kind of dogmatic about making sure what you say publicly is something you're very comfortable delivering on. But as we stand today, looking forward, is order growth of like flat to up next year?
Like is that within the realm of realistic possibilities? I think that's a major thing that people are struggling with right now.
Yes. Well, I'll start with a very short answer and I'll give the commentary to it. But I think it is absolutely something that we can do. And if we had to pick today and we're in the middle of our budget process right now, but if we had to pick today, I'd say Flowserve grows in the bookings range or in bookings next year and grows over 2019. So to give some of the color there, right?
I mean, there's no doubt we are in a challenging and uncertain market environment. But when we look at 2019, I mean, we've made incredible progress, right? Our original equipment and our project bookings are up 16% on a constant currency basis. We've been able to grow the overall aftermarket by 5%, but we're also dealing with this North American upstream correction that's impacting the valve business and clearly hurting us on that distribution channel and driving some adverse mix there. And then you look geopolitically, we've got uncertainty at almost I'm not going to say an all time high, but it is certainly at a high level where you've got Europe with Brexit and some of the Spanish stuff going on.
You've got U. S. China trade, you've got Middle Eastern tensions and then you've got the Latin America stuff as well. I mean, I think when we think about 2020, I'd say the best way to characterize it is, we think we're going to grow, but we don't think we can grow at the rate that grow in 2019. So I would just say it's a growing environment, but it's decelerated from where we are now.
We still think 2020 is a growth year. And so when you look at our project pipeline or our funnel, we've got good opportunities in refining, petrochemical and LNG. We've just moved we moved to our Flowforce CRM almost 1.5 years ago. So now we've got good visibility to that. And I'll say our 12 month funnel has come down in the last kind of 4 to 6 months, but it hasn't come down significantly.
It's only come down a little bit or very modestly. So we still feel good about the project funnel. On the aftermarket side, we must continue to grow that. We've got to continue to capitalize on the installed base. And then within the transformation, right, we've got 2 major initiatives around growth and one is commercial intensity.
And basically, that's making sure that we get our entitlement on the installed base and basically defining our playbook to capture that installed base and working with our customers. And then the other one is StrikeZone. And in StrikeZone, we've had tremendous wins. We booked over $100,000,000 on pipeline awards. We expect pipeline to continue into 2020.
We do have other strike zone initiatives as well. And so as those kind of play through, we've got the ability to take market share and grow with that. And so again, I feel reasonably good about our ability to grow. I just don't think it will be at the rate that we grew in 2019.
That's really helpful commentary there. Lee, you mentioned cash and that's been a really nice improvement there for you guys for a couple of quarters now. How much of this is still you guys manually doing the work every day, which and how where are you kind of in that systematic journey?
Thanks, Joe. I think we're making significant progress. It's still obviously a manual effort, but there are a number of, I would say, capabilities that are coming online.
The one I'm particularly excited about, for
the first time, we're launching, I would say, a new tool where I can see roughly 90 percent of my invoices in one system. So as you know, we've got over 40 ERPs. And so we basically launched in the last month a new tool that now gives us access to our customers and all their invoices, all their aging across our business. So now we have the tool, now we've got to execute and use it. And so we've launched change management and training sessions so people can understand what's there and how to data mine figure out what's past due and how to collect.
In addition, we're continuing to move collections efforts to our shared services operation in Hungary, and that also is driving more efficiency. Scott, you want to talk about inventory at all?
Yes. On the inventory side, again, it's not a perfect world, but I'd say probably the best way to describe it is both on AR and inventory, we've driven a significant process change and now we're in kind of the process adherence phase and then the next phase will be automation. And while we've got some tools that are starting to automate and give us better visibility, I feel very good that we are using different process that's going to absolutely drive results, and we're getting procedural adherence now the world. And so I think this is an area we've made really good progress and I would say we can continue to make progress as we're adhering to process and we start to automate more and more.
If I could just sneak in one last quick one. I mean given the short cycle weakness that we've already seen it hit FCD on the distribution side, If that accelerates, if there's more if weakness in those markets gets worse, how much of a how much margin do you think you can neutralize at this point? You've already had a lot of the impact. If we see volume decline further, can you offset that negative impact?
Let me just kind of set the scene for everybody on that. And I'm going to talk probably more about our ability to get orders and then I'll go to margins. But so basically our valves business is, it has about 40% through distribution and a big chunk of that is in North America. And so what's happened with the upstream side of the business, with the upstream pulling back, we've got upstream side of the business with the upstream pulling back, we've got distributors that have carry and these are the I'm talking about the stocking distributors that carry our valves in the upstream side and the downstream side. And so basically, as they get the signals where rig count comes down and production and completion start to come off, they really begin to clamp down on their inventory levels.
And so we saw that really start in Q2 and then in earnest in Q3. Now that destocking though actually has decelerated. And then what we need is if the environment stays the same, then our business actually has some tailwind because they've got to order product to deliver that. And so I actually feel okay that I don't see this another step down unless activity in North America took a dramatic change to even worse. And I don't think anybody is predicting that.
I think most people are saying that 2020 will be similar to the activity that we're in now. And if that's the case, we would get a little bit of a tailwind in terms of bookings for FCD. Now let's just say that, that doesn't happen and things get worse. I would say that the valve business or FCD is taking the appropriate cost actions within North America and at the facilities that deliver product there. And we would continue to do that.
And so the team is well versed on the levers to drive cost control. We'll continue to pull those as the market goes down. But I would just say, I don't see that as a likely scenario. I actually see flat to slight growth in the MRO business of FCD.
Thanks, guys.
Our next question comes from Andrew Kaplowitz.
Hey, good morning guys. Hey, Andy. Good morning.
Scott, so just following up on your comment about expecting overall order growth for 2020, again, not to tee you down too much, but how much incremental visibility do you have from your project pipeline versus your own initiatives? You did suggest that your funnel come down, but maybe you can comment on your conviction on the conversion of funnel that you're seeing today versus your internal estimates and how additive has strike zone and commercial intensity been to bookings now and expected in 2020?
Yes. So no doubt, the funnel has come down again slightly. It hasn't come down dramatically. But I just think as we kind of mature with the transformation in our process adherence, one of the things that we're trying to do is develop playbooks and develop competency in all of our functions. And I've actually been really, really impressed in kind of the last 2 years of how our commercial teams and our operations teams are working together.
And what I'd say is we're still kind of middle innings on that and we still have significant opportunity to do better sales and operational planning, do a better job at reducing our lead times, do a better job at driving costs down, do a better job of getting the right products in front of the right people. And so I just say there's still a lot of self help that we can do here. We track wins and losses. We track missed opportunities. And I just say, unfortunately, that list is far longer than I wish it were.
And there's every quarter, we've got things where we go, gosh, if we just done some things a little bit differently, we could capitalize on that. So the project so back to the question, right? The project funnel still looks good. It's a huge number out there. I still believe we can drive market share wins.
And if you combine those 2 together, we feel comfortable in our ability to grow in 2020.
Great. And sort of a related question, the sort of feedback around FCD margin in terms of its sort of pullback here in Q4 as possible. If I step back and just think about the mix issue that you have now and that you could have as OE continues to ramp up in FPD, how easily can you offset that mix headwind as you go into 2020 with these initiatives? You've talked a lot about lean. What kind of impact are you already having in the business from lean?
Yes. It's a really good question. I think the headwind is real, right? And so just go back to what I said on, we've got OE bookings that have grown 16% constant currency and our aftermarket is growing at 5%. And so by definition, we've got higher margins in aftermarkets than in our OE business.
And with those divergent growth rates, it absolutely puts pressure on the margin. What we've got to do is offset that with the things that we're doing in the transformation with supply chain savings, the value engineering, the manufacturing productivity, the lean and all that stuff. And so I think thus far, we've done a really good job of that. So even with the mix changes, we're still continuing to be able to drive margin certainly on the pump side. And then FCD has gotten hit a little bit harder with the that mix change.
But I think we still have a huge opportunity set
in the transformation. In my prepared remarks, I
said we're about 50% transformation. In my prepared remarks, I said we're about 50% complete with that. As we turn into the second half of transformation, a lot of the initiatives around operations and driving costs down and which will ultimately help us on the margin side.
Thanks guys. Good quarter.
Thank you.
Our next question comes from John Walsh.
Hi, good morning.
Good morning, John.
Hi. So I just wanted to touch a little bit again on capital allocation and kind of the forward look. I think you said in the prepared remarks $35,000,000 to be returned in Q4. Just kind of given where your dividend sits, that seems like we're going to see some more share repurchase, which is something we hadn't seen in a while, if I caught that comment correct?
Yes. I'll let Lee answer this. Go ahead, Lee.
Yes, John, that is correct. We bought about 100,000 shares in the Q3, and our goal is basically to offset some of the dilutions that's happening with our long term incentive plan. So that's the main focus as we were looking at the share count and we wanted to normalize a little bit for some of the dilution that's been taking place.
Got you. Okay. And then, I guess, maybe Scott, can you talk a little bit about what you're seeing on price cost? Obviously, last couple of quarters, you've gone out selectively in certain product categories to get price, kind of an update on what you're seeing there?
Yes. So just as a reminder, we did 2 pretty significant price increases in 2019. 1 was at the beginning of the year and then one kind of in the at the end of Q1. And I feel reasonably good about our ability to stay on the positive side with this, but obviously, with FCD margins pressures, we've got to do more there. And so we're we continue to relook our pricing.
We will do another annual price increase the end of this year. And what I'd say is it's a combination of tariffs and inflation. And so we've got to make sure that we offset that. And so part of the transformation is the pricing work stream and bringing that analytical rigor to how we price and how we think about pricing. So I think we'll continue to do good things there.
And then on the kind of the project side of that, we are seeing, I'd say, a little bit more discipline on the pump pricing. And so as pump providers and the bigger ones that provide the project stuff, I think everyone's getting a touch more discipline. I'm not going to say we're getting unbelievable discipline in pricing, but I do think it's improved with the capacity levels coming up. And then where I'd say the concern still is, is on the valve side. And so the engineered valve side, in particular, is just an area that prices is not where it needs to be.
And so we're focused on that, but we're probably more focused on how do we take cost out to make sure that we're not eroding too much margin there. But overall, I feel reasonably good in our ability to get price. We've been able to move it up this year, and we'll be pretty aggressive at the end of the year and the 1st part of 2020 on it.
Great. Thank you for the color.
Thank you.
Our next question comes from Deane Dray.
Thank you. Good morning, everyone.
Hey, Dean. Good morning.
Hey, lots of good color. If you just step back a year ago plus as to what issues you were addressing on the call, you're now it's just getting to be such a more refined story and you're really pushing the team and you can hear it in the cadence of both the answers, but also on the outlook. And on that point, I was really interested in That's why
it definitely feels better, Dean. There's no doubt about that. All right.
Good. So I love hearing the fact that you do kind of a post mortem on business lost. And in reference to the answer around the valve pricing, when you look at like a Pareto chart of the business that you've missed, is it price? Is it product specs? Is it delivery?
Just what are the biggest issues on what has to change?
Yes. I don't want to give a road map to our competitors, so I'm going to be a little careful on the here. But I would say it's a little bit of everything, but the ones that frustrate me are the self induced ones, right, where we're not communicating or we didn't do the right thing or we over spec something and made our product at a higher cost than it needed to be to our competitor or we got super conservative on lead times and we weren't able to deliver on that. But I would say the list unfortunately again is longer than we would like and there's lots of reasons there. Our focus though is to mitigate the ones that we can control and making sure that we've got tight correspondence and cooperation between our sales and our operations team.
And just by doing that, Dean, we've got pretty significant opportunities. And so we're going to keep working that. And again, as we mature with our playbooks and moving through the Flowserve 2.0, I have no doubt that we continue to make progress in our ability to capture more market share as we go forward.
That's real helpful. And like a year ago, there was lots of consternation about past due backlog and that doesn't seem to be an issue anymore. Is that all been put to bed?
Yes. Look, we're never satisfied, right? And I'll say we're not delivering on time 100% of the time, but it is not the issue that it was when I came to Flowserve. And so the operational teams are doing a really good job. We're definitely focused on our deliverability.
But I would say like there's more work to do there, right? And so as we kind of get better at on time delivery, then we shift our focus to lead times and making sure that we can be even more that we're going to work on to continue to get better at Flowserve.
All right. That's good to hear. And just last topic for me. I wanted to go back to one of Joe's questions about destocking. And this really has to be one of the most overused terms that we've heard companies talking about or blaming the short cycle pressure that they're seeing.
To us, when we hear destocking means the sell in to the distributors is less than the sell through. And this typically can't happen for multiple quarters. If it does, it's usually a falloff in demand. But your answer really was calibrated where you're looking at the sell in versus sell through. So if you just clarify for this quarter, do you think that has been at a stage where they have to replenish?
And what kind of volumes might you see out of this replenishment?
Yes. So Q3 was definitely down for us through the distribution channel. And I'm speaking predominantly about on the valve business. And so there's no doubt that they're destocking in the Q3. And to your point, that can't continue in a reasonably stable environment.
And so we think at some point, we start to get more orders. And I would say, we are getting orders from our stocking distributors. They're just not as high as we've seen before, and they're significantly down from even the early run rates in 2019 or certainly on the year over year comparisons. But I think if you go think about the North American activity and if we've got stability in terms of production completions in both the gas and the oil side, then that's going to be a little bit of a tailwind for us hopefully in kind of a Q1, Q2 time frame in 2020.
That's real helpful. Thank you.
Our next question comes from Nathan Jones.
Hey, good morning. This is Adam Farley on for Nathan.
Hey, okay. Hey, Adam.
Hey, turning to midstream, I know it's a strike zone focus for you guys. I think you guys mentioned a pretty nice project award there. Could you provide any color on how that market is doing? Are you seeing any deceleration in projects or any projects getting pushed to the right?
Yes. No, it's a really good question because at some point, they're not going to keep spending the capital that they are. But I we've got good visibility into kind of Q4 and early 20 20 on this. So I feel reasonably good about our ability to continue to get midstream work, both the pipeline side and the storage side. And what I'd say is we're starting to win the work with our entire portfolio.
So really bearing the power of the pure play, leveraging the efficiency technology that we have with the pump side. And this is a space that we really weren't in before. And so we're absolutely taking market share. And we feel very good about our ability to do that and win work. And I would say expect more awards for us.
But I'm not naive to think that this does slow down at some point. But I would say for the next 6 months, we still see pretty significant opportunities in pipeline. And then I think you're going to see some storage build out and kind of if you go one more step downstream, you start to see some capital spending there. And then the other thing I'd add is we hadn't really focused on the midstream side globally. We are more the initiative on StrikeZone was very much a North American focused initiative.
We're now starting to migrate that around the world. And again, I think we're looking pretty good for some midstream pipeline awards globally here as well.
Okay. That's helpful. And then just shifting to your water business and specifically desalination. I know it's a small part of the business portfolio. Obviously, it's not tied to the energy markets.
Maybe just some color on how you view the business? What are the opportunity sets there? Just any color would be great. Thanks.
Sure. Yes. So we had a press release about a week ago on 2 NICE awards in the Middle East, the Taweelah and their IB project in the Kingdom of Saudi Arabia. And so for us, desalination is a nice market and where we have the technology is in the pump side. And so our efficiencies allow operators to keep their energy cost down, which is the largest cost of doing desalination.
And so we've got some preferred technology there and it works real nicely. What we're trying to do is do more of a pure play opportunity with desalination. And so we've got pressure exchange technology, we've got valve technology. And what we want to do is ultimately start to put more products and services around desalination. But as you know, water and particularly drinking water is a huge issue for the entire globe, and we feel very good about the share on desal.
Okay, great. Thank you.
Our next question comes from Brett Linzey.
Hi, good morning guys. Hi, Brett.
Hey, just wanted to come back to the pump combination of the 2 segments. It sounds like you've made some very good cost traction on a lot of those initiatives. What have you realized from a savings standpoint year to date? And how much more savings do you think you can wring out of that as we look into 2020?
Okay. So I missed the one part. You said on a savings standpoint? Correct.
Just cost count.
Yes. Okay. Yes. No, so I'll just start. The reason we brought the pumps together really wasn't the cost side.
It was more about the customer. And so what we're seeing now is a concerted front with our pump team, talking to customers properly and really balancing the supply and the demand more appropriately than we were. And so I'd just say, with the 2 different platforms, we did not have the collaboration or the cooperation as you would expect from 2 entities even within the same company. So that's now completely changed, and that team is working incredibly well together. We are definitely seeing cost savings, right?
So there's no doubt, right, we have 1 team versus 2, and so we got immediate SG and A savings there. And I'd say probably the bigger prize will be kind of in 2020 beyond as we really start to rationalize more of the engineering function and more of the footprint to operate. And so I think we've definitely captured savings, but I'd say there's more savings that will drive gross margin expansion here as we look into the future.
Are you able to quantify what you're targeting there for 2020?
No, I really don't want to do that in particular. We'll come out with guidance as we always do at the end of Q4 and then we'll talk about what 2020 looks like from a margin perspective.
Okay, great. And then just one follow-up. Good to see positive free cash flow here in Q3. Conversion still running a little bit light about, I think about 50% as a percent of adjusted net income. In terms of the 75% conversion target for the year, any change in that thinking now?
Brett, this is Lee. No. We still see have a line of sight to the 75% that I communicated earlier in the year, and that's what we're working to. I mean just in general, there's a significant more focus on cash and the importance in cash. And so this is a metric that we look at very closely, and we still feel good about 75.
Okay, that's great. I'll leave it there. Thanks. Great, thank you.
We have no further questions at this time.
All right. Well, we greatly appreciate everybody joining us today. And certainly, if you have follow-up questions, don't hesitate to call Mike Mullen or myself. And we look forward to seeing you at some investor conferences in the weeks months ahead. And thank you all again.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.