Welcome to the Flowserve First Quarter 2019 Earnings Call. My name is Paulette, and I will 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 this conference is being recorded.
I will now turn the call over to Jay Roueche, Vice President of Investor Relations and Treasurer. Sir, you may begin.
Thank you, Paulette, and good morning, everyone. We appreciate you participating in our call today to discuss Flowserve's financial results for the 2019 Q1. Joining me this morning are Scott Rowe, Flowserve's President and Chief Executive Officer and Lee Eckard, 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 May 3, 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 available on our website at floserv.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.
Thanks, Jay, and good morning, everyone. Flowserve's first quarter results are a strong start to the year, and I'd like to begin by recognizing our associates for their continued engagement and enthusiasm around the significant changes that we are driving within the company. Our associates are leading the Flowserve 2.0 effort to accelerate growth, reduce complexity and streamline the Flowserve operating model and we are making great progress. We executed well during the Q1, delivering $0.44 of reported EPS and $0.41 of adjusted EPS with transformation costs and below the line foreign exchange impacts more than offset by net realignment benefits. As realignment activities wind down and lower cost transformation initiatives continue, we expect the size and number of adjusted items to moderate in the years ahead.
We fully intend to narrow the the year over year margin expansion again this quarter. Adjusted gross and operating margins increased by over 300 basis points in the Q1. Improving free cash flow is also a priority for us, and I am pleased with our stronger performance in the Q1 as compared to a year ago. The improvement is still primarily attributed to an intense and manual effort, but I am confident that we're beginning to develop the underlying process changes needed to deliver more sustainable and consistent cash flow conversion at higher levels. As many of you know, Flowserve and our industry as a whole is impacted by seasonality and the Q1 is traditionally the lightest of any year.
So I'm pleased with the performance in each of our segments this quarter. We are off to a good start in 2019. Our newly formed FPD segment delivered strong operating improvement, including 450 and 440 basis point improvement in adjusted gross and operating margins respectively. While we no longer report on the former IPD segment, I will share that during the first quarter, IPD's former facilities in aggregate improved their operational excellence, on time delivery, productivity and adjusted operating margins year over year. As I discussed in our Analyst Day last year, the rationale for the combined FPD segment is to better serve our customers and fully leverage the scale of our pump platform from both a manufacturing and aftermarket perspective.
FPD's strong 24% total bookings growth, which was led by a 56% increase in original equipment awards benefited from this combination as improved sales force collaboration allowed us to capitalize on a number of market opportunities. We also expect cost benefits and additional manufacturing improvements as we implement common processes and best practices across the platform. The FCD segment, our Valve and Automation business once again delivered a strong quarter, including 230 and 290 basis point improvement in adjusted gross and operating margins on modest 1.8% revenue growth. FCD's bookings were down 2.3%, but included roughly 3% of negative currency impact. Additionally, the comparison period as last year's Q1 represented FCD's highest bookings period of the year.
We expect FCD to again deliver strong full year performance, including improved collaboration with our FPD organization to better leverage the entire Flowserve portfolio to support the increased project activity. Looking now at our overall bookings and end markets. We're particularly pleased to have produced $1,070,000,000 of total bookings, representing year over year growth of 14.9%, including a nearly 25% increase in original equipment bookings. These strong results are a function of our growth oriented transformation initiatives combined with more robust infrastructure spending. As market visibility continues to improve, we expect near term booking levels to remain solid.
Additionally, the health of the market is giving us confidence in our ability to continue to improve our pricing. We're seeing good results from our increases that went into effect at the beginning of the year and we are pleased with the acceptance and resiliency that we have seen thus far. We have initiated further price increases over the last few months where we have the opportunity to price at higher levels. Flowserve delivered the highest quarterly level of bookings since the Q2 of 2015 and our 4th consecutive quarter at over $1,000,000,000 1st quarter bookings continue to be driven by smaller run rate and upgrade activity, most of which are below $10,000,000 in size. We did obtain 1 larger oil and gas award in the $30,000,000 to $40,000,000 range, but have yet to see a significant increase in new large project activity as these customers continue to work toward FID on many of the sizable opportunities.
We will remain disciplined on pricing for these larger projects to ensure that Flowserve earns the appropriate profit for the value we deliver. During quarter, our aftermarket franchise generated nearly 6% bookings growth, representing the 4th consecutive quarter with bookings over $500,000,000 As we successfully embed many of the commercial intensity initiatives across our global aftermarket platform, we are capturing an increased share of our customers' maintenance spend. We continue to expect our customers will focus on facility maintenance, increased efficiency and meeting changing regulatory requirements in the near term. When combined with our growth oriented transformation efforts, these factors will provide ongoing opportunities for Flowserve to expand the aftermarket business. Now from a served end market perspective and starting with oil and gas.
Bookings in the first quarter increased 45 percent year over year, driven primarily by FPD's 66% growth, including our largest award of the quarter at over $30,000,000 in Asia Pacific. Both FPD and FCD, however, saw the bulk of their orders in the $3,000,000 to $15,000,000 range, primarily in the Middle East and Asia Pacific. Downstream investment drove much of the increase as we continue to support refining modifications for clean fuel production and efficiency upgrades. With relatively stable commodity prices, we expect increased project activity to occur near term in both downstream and midstream oil and gas. While Flowserve has traditionally been predominantly downstream focused, we are utilizing our strike zone initiative within the transformation to successfully increase our pursuit and more importantly, our capture of midstream pipeline of line of sight into additional midstream opportunities throughout 2019.
Finally, we have yet to benefit from the expected large project activity in the marketplace, both those still in the FEED stage and the ones already awarded to EPCs. While timing is always difficult to predict, we do expect increased refining in LNG projects to provide good opportunities for R and D for our industry in the coming quarters. In chemicals, our quarterly bookings increased approximately 6% year over year, including 4% of currency headwind. Both FPD and FCD We expect increased investment in Asia and the Middle East as oil majors and national oil companies increasingly pursue integration up the petrochemical value chain. The power market remains our most challenged industry with 1st quarter bookings essentially flat year over year.
FCD's 1st quarter bookings, however, increased 13% in this market as it benefited from several nuclear awards across North America, Asia Pacific and Europe. We expect industry wide headwinds to continue in power markets for the near term, although limited opportunities do exist related to fuel switching, new build nuclear in China and fossil fuel development in Asia. We also continue to support existing Western nuclear facilities with maintenance, upgrade and life extension activity. Additionally, the concentrated solar power market is a niche opportunity for Flowserve and growing renewable space. And we have a differentiated technology offering that we provide to this market.
1st quarter bookings in general industries declined 5% year over year, including nearly 4% of currency headwind. FCD was down approximately 23% in this market, primarily due to lower distribution activity that was negatively impacted by North American land based upstream volatility due to oil pricing pressures in the Q4. Given the oil price rebound this year, we expect to see growth in North American upstream through our distribution channel later in 2019. General industry bookings also declined in mining, pulp and paper and agriculture, although each of these markets currently represent less than 3% of our overall mix. Lastly, representing our smallest market, water bookings increased approximately 24% in the Q1, including several small awards in both segments and primarily in North America.
From a geographic standpoint, we delivered strong growth in all regions except Europe. Compared to the 2018 Q1, North America was up nearly 18%, the Middle East and Africa increased 45% and Asia Pacific was up 21%. Latin America also grew nearly 20% sorry, grew nearly 27%, but off a low base. European bookings declined nearly 11%, including approximately 7% of
Lee? Thanks, Scott, and good morning, everyone. Flowserve delivered a very good start to the year with adjusted earnings per share of $0.41 in line with our expectations. On a reported basis, 1st quarter EPS was 0 point 4 $4 which included realignment benefit of $0.09 $0.04 of transformation charges and $0.02 of negative below the line currency impacts. First quarter is traditionally our seasonally low quarter in the year.
Revenues were $890,000,000 a decrease of 3.3% versus prior year. Excluding approximately 5% of headwinds from currency and divested assets, revenues are up about 2% year over year. Additionally, this year only 17% of our Q1 revenue utilized over time percentage of completion accounting compared to approximately 23% a year ago. This reduction was a result of differences in sales mix between the two periods, disciplined spending on larger projects in progress and the deliberate efforts we made last year to ensure that the new smaller has a higher percentage of contracts where revenue will be recognized as work is completed and shipped. As a result of the growth we delivered in recent quarters in aftermarket bookings, aftermarket sales increased for the Q1 by 3.4% or 7.9% on a constant currency basis to 4 70,000,000 and comprised 53 percent of our sales mix, which was a 300 basis point increase over last year's Q1.
Now looking at margins. 1st quarter adjusted margin increased 3 40 basis points to 33.7%, matching the highest quarterly level since 2015. Both segments contributed to the improvement with FPD expanding adjusted gross margin by 450 basis points to 33.7 percent due to continued operational improvements, fewer but higher margin large project POC contracts in progress and a 500 basis points mix shift towards aftermarket sales. SCD's adjusted gross margin increased 230 basis points to 34.8%, a modest revenue growth as it continues to operate at a high level. On a reported basis, we had a 280 basis point increase in gross margin to 34.6%, which was driven by essentially the same factors as well as approximately $1,000,000 of less realignment expense in 2019.
Adjusted SG and A decreased $5,200,000 to approximately $214,000,000 or 24% of sales, relatively flat with last year's Q1. On a reported basis, 1st quarter SG and A decreased $24,000,000 which included a $17,000,000 net realignment benefit. At the operating level, our adjusted operating margins improved 3 10 basis points to 9.9 percent as a result of our strong gross margin and ongoing tight cost controls. On a reported basis, operating margin increased 5.40 basis points, where improved operating performance further benefit from a net reduction of approximately $20,000,000 in adjusted items, primarily related to realignment. Our adjusted tax rate was 25.6%, slightly lower than our full year adjusted tax rate guidance of 26% to 28%.
Turning to cash. We delivered a substantial year over year improvement in free cash flow. Strong earnings, some timing benefits and our continued focus on working capital produced operating cash flow of $39,000,000 a 150 $9,000,000 improvement versus the 2018 Q1. Working capital declined over $100,000,000 and as a percent of sales decreased 360 basis points to 28.4%. Scott mentioned, we are working on drive we are working towards driving company wide improvements within our order to cash and inventory processes to create a sustainable systemic operating model.
These changes are the necessary foundation to enable Flowserve to achieve our longer term cash conversion target. While much of the quarter's improvement was again driven by intense focus and highly manual efforts, we will continue this brute force approach until the enabling technologies are in place and the underlying process improvements take hold. In the Q1, we returned $25,000,000 to shareholders through dividends, paid off $15,000,000 of long term debt and invested in the business with $11,000,000 of capital expenditures. We ended the quarter with a healthy cash balance of nearly $640,000,000 a sequential increase and improvement of over $100,000,000 from a year ago level. As I'm sure you've seen from other companies, you may have noticed in our balance sheet, at the start of the year, a new lease accounting standard was implemented, which required companies to account for operating leases on the balance sheet.
For Flowserve, this charge added about $200,000,000 to both assets and liabilities as of March 31. Turning to our 2019 outlook. As we mentioned previously, we are actively reinstilling a culture of excellence, continuous improvement and a focus on meeting our commitments. And with our Q1 results keeping us on pace for the full year, we are reaffirming our full year targets. On adjusted basis, we continue to expect EPS between $1.95 $2.15 a share and $1.60 $1.80 on a GAAP basis.
Similarly, we also confirmed our expected revenue growth of 4% to 6%, including full year headwinds from currency of 1.5% and roughly 0.5% from last year's business divestitures. This level of performance will keep us on track with our longer term 2022 targets we laid out in December. The adjusted EPS target range excludes 2019 expected realignment transformation expense of approximately $60,000,000 as well as below the line foreign currency effects and the impact of potential other discrete items, which may occur during the year such as acquisitions, divestitures, tax reform laws, etcetera. Net interest expense is expected in the range of $55,000,000 to $57,000,000 with an adjusted tax rate of 26% to 28%. Additionally, we expect traditional back half weighted seasonality generally in line with the 2018 phasing as we delivered additional transformation benefits.
From 2019 full year cash usage perspective, we expect to return approximately $100,000,000 through dividends to our shareholders. Capital expenditures are expected in the $90,000,000 to $100,000,000 range. We also expect full year debt repayment of approximately $60,000,000 and to contribute approximately $20,000,000 to our global pension plans, mainly to cover our ongoing service costs as U. S. Plans remain largely fully funded.
Now, let me now turn it over to Scott for his closing remarks.
Great. Thank you, Lee. As I wrap up, I would like to spend a few minutes on our outlook and the progress of our transformation efforts. When we formally commenced the Flowserve 2.0 transformation program a little over a year ago, we knew it was going to be a multiyear journey and we are convinced that Flowserve had a significant opportunity to better serve our customers, our employees and our shareholders. A year into the journey, I'm very pleased with the progress we've made.
We have built momentum and have increasingly shifted to a self sufficient internally led program, while greatly reducing the amount of third party reliance. We are encouraged by the results that we are starting to see in all areas of the business. Flowserve has improved operationally as demonstrated by 4 consecutive quarters of increased year over year adjusted operating margin. We've driven improvement in our manufacturing productivity, our planning and scheduling as well as in our supply chain management. Our growth initiatives combined with an improved market outlook have driven 4 consecutive quarters of $1,000,000,000 plus bookings.
As we continue to push the transformation initiatives deeper into our business, we are confident that we will build on the results delivered today. Perhaps most encouraging, there's still significant opportunity ahead of Flowserve. Much work remains to achieve the 2022 targets that we presented last year, but we are instilling the culture, developing the processes and changing the operating model to create sustainable long term value. We're making good progress on both the health and the performance of Flowserve. We're still in the early phases of the transformation, and I am convinced there are significant opportunities ahead of us.
Our commitment to Flowserve 2.0 combined with the strong first quarter performance gives me the confidence that we can deliver on our 19 commitments. Operator, we have now concluded our prepared comments, and we'd now like to open the call to any questions.
Thank you. And our first question comes from Michael Halloran from Baird. Please go ahead.
Hey, good morning everyone.
Hey Mike. Good morning Mike.
So just some questions then on the margins as we look through the year here. Obviously, some of the prepared remarks talked about the mix benefit on the aftermarket side in the Q1. Obviously, the margins from here would imply some pretty healthy results relative to guidance potentially. So could you help with that cadence through the year here? What was sustainable from the Q1 as we work forward?
And how those cost initiatives and mix and things like that should play out as we work forward?
Yes, sure, Mike. I'll start and then I'll let Lee fill in because I'll probably miss something here. But I'd say there was a 3% mix shift towards aftermarket in the Q1. And so that was one thing and that will probably unwind as we go throughout the rest of the year. But what I'd say in the Q1 is that we had no major surprises.
And historically, at least as long as I've been here, we've had a surprise almost every quarter. And so we're doing well on execution and eliminating that. Additionally, we're on the positive side of the price cost curve. And as I discussed in my remarks, we've now had 2 pretty substantial price increases in the year. And we feel pretty good about our ability to continue to our ability for that to continue to stick throughout the year.
And then we're just more selective on the work that we're taking. And so as we think about what goes into our facilities and what we can execute, we're making sure that we can deliver value when we deliver that work. And then finally, the other thing is that our past due backlog is significantly down from where it was a year ago. And so that was consuming a lot of cost and it is incremental cost in that backlog and as that's cleared and in a much better place, the margins are in a good place right now and we expect to keep a similar result throughout the year. Lee, you want to add to anything?
Yes. I think you summarized it pretty well, Scott. Our focus is to drive year over year margin expansion. And as Scott mentioned, the key driver is price ahead of inflation. We're driving supply chain savings as part of our Flowserve 2.0.
We're executing better on projects. So just no we're not having surprises like we had in the past. We're also winning the right contracts too. We're much more selective on what we're winning and executing on that. But the last item is 1, so all those should continue through the rest of the year.
The last one is the aftermarket mix. And our expectation is that it's going to be more balanced and especially with the significant amount of orders won and what's in our backlog, we're going to see a lot more, obviously, original equipment through the balance of the year. So while we are driving year over year margin expansion, you should not have the conclusion that, that will lead to sequential margin expansion.
So if I can unpack that then, you're basically saying mix is going to be a swing factor from here. But as far as internal initiatives go, price cost, things like that, it feels like more of a tailwind from the Q1 looking ahead. Is that fair?
Yes. Mix is the headwind and then we offset that headwind by transformation activities and doing the good things that we did in the Q1.
Great. And then a comment on the pricing side. Is the pricing limited from ability in the marketplace to some of the aftermarket in the more higher end niche applications. How does it all could you talk about that side, but then how does pricing look on the larger projects, those $3,000,000 to $15,000,000 plus kind of range, how competitive is it? And obviously, you're being more price disciplined, but love to hear about the opportunity set there as well.
Yes, I'll just talk about what we've done this year so far and then I'll talk about a little bit about the current environment. So we did our price increase earlier this year than we ever have. In fact, we announced it in December and went into effect in the early parts of January. And that was pretty much across our entire offering with the exception of the engineered order products that we build up that cost and then price off the buildup of the cost. We're seeing really good resiliency in the price increase that we issued in the beginning of the year.
And that affects all of our business, right? It's seals, it's parts on the aftermarket, it's valves and it's on more of the base product within the pump portfolio. And so that's got good traction. We're seeing good results from that and we expect to continue that throughout the year. In addition to that, what we've done in the engineered order is we started to raise our margin expectations as we've been able to drive cost out in the execution instead of passing that on to customers, we're capturing that ourselves.
And so we're pricing at higher levels than we have in the past and certainly much higher than what we did in the Q1 of last year. And then finally, the third piece of this is there are selective areas where we've got a preferred position or a niche opportunity where we've also added price increases on top of what we've done at beginning of the year. So we feel very good about where we are on price right now relative to cost, inflation, tariffs and everything else. But there are areas of concern. And what I'd say is the areas are primarily the larger projects and for some reason larger projects attract more attention.
And what we're seeing from peer group and competitors is that that gets incredible focus on price reduction and becomes highly competitive. And so we understand that and what we're going to do is we're going to price our big projects accordingly. We would love to have some of those in our backlog and in the portfolio. But at the same time, if we can't get the price that makes sense to create ultimate value, then we're not going to do those jobs. But there still is it's surprising to me, there still is a lot of pressure in large pump projects and in large more engineered valve projects as well.
But that's a very much smaller percentage of your portfolio today than historically, correct?
Absolutely.
Our next question comes from Deane Dray from RBC Capital Markets. Please go ahead.
Thank you. Good morning everyone.
Hey good morning, Dean.
Hey, you guys should really do more re segmentations, if you can put it in quarters like this. So, maybe the first question is in cash flow. So we like seeing the progress year over year. And I was interested that both of you talked about, still in a intensely manual process. Maybe share with us where and how does that get automated or more systemized, if I can use that word?
But then also, it's not just the speed of order to cash, but what's the ultimate plan for working capital? Because it just seems your capital intensity is still a bit too high for the businesses that you're in. And where and how are you looking to drive down working capital?
Yes. So Dean, let me start and then I'll let Lee jump in and go into the details here. But we're making good progress on working capital, but this is the area that we continue to talk about right closer with highly decentralized and trying to get this accomplished across the enterprise has just been incredibly hard work. And so right now, we're doing it with management attention, intensity and a big manual effort. Ultimately, we want to have far more transparency and the ability with an integrated system to do this from a systematic standpoint.
And what I'd say is, the manual effort is getting good results, right? We're down significantly from where we were last year, 32%, and now we're at 28.4%. But we still have a long way to go. And this is not our aspiration. In fact, we're fully striving to be somewhere in the closer to the 20% mark as a percentage of revenue.
We know we have a long way to go here. As part of the transformation, this is a major initiative both on the inventory side and the receivable side. But we're definitely getting traction. And from a year ago, we're in a far better place than we were. And so you'll continue to see improvements here, but it's really going to be slow going until we can really start to have an integrated and more systemic approach to this.
Lully, why don't you go in a little bit more on the cash flow side and touch on working capital?
Sure. So as I mentioned, pretty big improvement, $160,000,000 driven $43,000,000 in earnings, dollars 85,000,000 in working capital and about $44,000,000 that I would say is more timing related. So we do expect that kind of bounce back during the year. But as Scott mentioned, there's intense focus here on working capital and importance. So some of the things we've talked about in the past is one of the first things we did is we made sure everybody was incentivized to focus on working capital.
There is not a location you would go to where people are not talking about the progress we're making on inventory and receivables and that wasn't the case before. But the manual effort where we would like to get to are places where we have centralized billing, centralized collections, centralized dispute management system. Today, we don't have those capabilities. Right now, it's all at our sites. And so right now, while the manual effort, people are aligned and focused on it, as we said, it's kind of brute force efforts.
But we are putting plans and processes in place to centralize, get scale. You'll be embarrassed to say that in many cases, I invoice I send invoices by mail. A lot of often it's snail mail. Those should be electronic payments. And so those are some of the things that we need to do to drive the balances down.
And as Scott said, our goal our short term goal is to get to around 20%.
All right.
And Deane, one last thing I failed to say on the incentive structure because Lee brought it up and I said this in the Q1, but it is driving behavior. And so now we've got everybody incentivized with working capital. And then the other thing we did is historically at Flowserve, that incentive was an end of year metric, which obviously is not going to help you bring down working capital throughout year. And so this year, we've changed that and it is your average. And so we're really getting that attention much earlier in the year and our teams are focused on driving that down.
Got it. That's all really helpful. And then the second question is a little bit more reflective of this what happens when you start making progress and you can see Flowserve 2.0 turning the corner here is when do you get to start playing offense? It sounds like yesterday there'll be some energy pumps and valves assets coming onto the market. And it just raises the question, when will you be ready to go back into M and A?
What's the timing? What makes sense? And we'd appreciate some color on that. Thanks.
Yes, sure. Look, obviously, it's a dynamic space right now in the industrials, quote control market. And so we have our ear to the ground and we're watching things evolve and move forward. For us, we are very focused on Flowserve 2.0 and driving that agenda and getting the results that we need. I'm not going to commit to say Q3 this year, we're ready to go or Q4.
But what I'd say is we are definitely making progress. And so every quarter that we go through, I'm more confident that we've got a platform that we can integrate something into. But as we just talked about, right, it's still highly manual and it's not as clean and simple as we would want. And so as we start to move forward and develop our enterprise wide IT systems and start to have more consistency in our operating results, then I start to get more comfortable about moving towards the offensive. Now with that said, we've got to make sure that there's a requirement that we are generating value if we were to go outside and look at acquisitions.
And so it's got to be financially attractive. We've got to be able to integrate it almost seamlessly or have the confidence and the ability to integrate. And we also still need to maintain the financial flexibility. And so we're going to be prudent about what those are and what I'd say right now is we're still very focused on the Flowserve 2.0 agenda. But if we can have a couple more good quarters like we had in Q1, then we get more confidence in our ability to execute and run a bigger business.
That's all good to hear. Keep up the good work. Thanks.
Great. Thank you, Dean.
Our next question comes from Andrew Obin from Bank of America. Please go ahead.
Yes. Good morning, guys. I was going through my model. I was trying to figure out when was the last time you had positive free cash flow in the Q1. It only goes back to 2005 and I haven't seen any quarters like that.
So congrats.
Great. Thank you, Andy.
So question on that. You sort of talked that there were one time items in the quarter on working capital. I just want to make sure that and I understand that there will be payback throughout the year, but what are the chances of us seeing quarters with negative free cash flow in 2019? Or should we assume that they will go up and down, but pretty much free cash flow will be positive throughout the year?
Lee, you want to make that one?
Yes. So without giving like quarterly guidance on cash flow, we do there is we do have a major, I would say, outflow is going to happen in the second quarter around compensation. So that will be a drag in the quarter. But our focus, as Scott talked about, is continue to drive working capital improvement quarter to quarter. And so that should continue to build.
So I'm not going to give guidance on the Q2 cash flow, but I do expect you will see a change in liabilities in the Q2.
Yes. Andy, I'll just add. Look, we've got an intense focus on cash flow right now. We just talked about working capital. And as you know, right, 1st quarter is always the most challenging on working capital.
So we got off to a reasonably good start. We expect to improve that as we go forward. And I think with that focus and the expanded margins as we look at the back half of the year, we feel pretty good about staying in a good space on cash flow.
Right. But I just want to make sure that there's historically, right, I mean, if you look at the swing, the swing from Q1, Q2 is fairly substantial. So if you are in fact sort of gaining operational traction, maybe it's breakeven, but second quarter, can you comment whether there is a chance that it can be negative or not? And I know that you don't guide, but I'm just trying to understand the magnitude of swings that we could see in the Q2.
Yes. There's some timing issues, but I wouldn't expect a big step backwards here.
Good. Second question on pricing. You highlighted the fact that pricing is getting better. And I'm just trying to understand what's driving it. Can you comment maybe on industry capacity?
Clearly, for whatever reason, people are behaving more rationally. Why all of a sudden you have ability to implement pricing and for pricing to stick? Thank you.
Sure. On the pricing side, again, we've done some really good work and we've been far more sophisticated about how we price and where we have our opportunities than ever before. And so we're using a lot of data and a lot of analytics and what that tells us is that we've got opportunities in certain areas. And so we're trying to what I would say is we're trying to catch up probably to some of our more sophisticated peers on pricing and so we've done that. And then in addition to that, the backdrop of tariffs and cost inflation also give us the ability to have true and honest discussions with our customers to say, hey, here's the real environment.
I do think there are we are getting some traction with the peer group and competitors, the base business. And so we're seeing folks lift prices up a little bit. But like I said earlier, where we still see highly high degrees of competition is in the more engineered to order type projects and the bigger projects they are, it's attracting more people. And for whatever reason, we're seeing significant price pressures on anything in the large project sizes. Well, congrats.
Great. Thank you.
Our next question comes from Scott Graham from BMO Capital Markets. Please go ahead.
Hey, good morning.
Good morning, Scott.
Just a couple of questions around sales, some expenses and what have you. So the implied organic on a full year basis is 6% to 8% thereabouts. And we have the Q1, which kind of came in at 2%, and I get the whole POC accounting change stuff. I guess what I'm wondering though is that your second and third quarter comparisons are pretty tough. So it would seem to me that you're expecting a pretty back half loaded and perhaps even 4th quarter loaded sales year.
Can you kind of give us a little bit of color there? And does that mean that, that 4th quarter could be maybe fairly mix negative for margins?
Well, here, let me talk about our revenue profile and then we'll hit margins. I'm going to delete it off and then I'll let Lee clean up here if I miss something. But let's just talk about Q1. You typically, as you know, right, that's seasonably our lowest quarter and we expect to go up from here. And I would say, in the Q1, I'm pleased with the execution that we had.
So we didn't have any major surprises, and it was pretty much in line with our internal expectations. We have improved operations dramatically from a year ago and so we were able to clear that huge past due backlog that we talked about a lot in Q1 and Q2 of last year. And then we continue to expect revenue growth throughout the year with the increased backlog, right? So with these bookings, we've got higher backlog and we expect to convert that at a higher level as we move forward. So Lee, do you want to talk about a little bit of the finer details on the revenue side and then we can talk about the forward look there?
Yes, sure. So just couple of points. First, I would say the Q1 was roughly in line with our internal expectations where we recognize less project revenue than last year. At the beginning of the year, we had fewer large contracts that qualify for the POC accounting versus last year. Last year, the 60 6 impact on revenue in the Q1 was $71,000,000 Unfortunately, the margin on that incremental revenue was really low, was like 9%.
The good news is that the margin in the backlog starting this year is clearly better. So the first quarter revenue, the net is that our sales are down, but our margin is up. The second thing I would say is that, as we said in our guidance, you alluded to it, we're still expecting 4% to 6% growth. So if you just do the math, that would expect a 6% to 9% balance of the year revenue growth. Now the good news is that from our perspective is that if you look at our backlog and you assume a certain conversion or historical conversion, our book and burn is roughly equivalent year over year.
So that gives us the confidence that we can hit the sales number. But your point on margins going forward, there's clearly a second half lift, as I talked about, between the 6% to 9%, but it's going to have a lot more equipment in it. So that will put some downward pressure versus the aftermarket margins.
Yes. So like we said before, the aftermarket OE mix goes more OE in the back half of the year, and so that's a headwind to margins. And we're trying to offset that margin headwind with our pricing and with some of the stuff in the Flowserve 2.0 on cost reduction.
Understood. That's very clear. Thanks. My other question is around corporate overhead. And honestly, from the outside looking in, that's always a tough one to estimate.
Is this a reasonable run rate number in the Q1, plus or minus $3,000,000 for the year and then it goes higher in the Q4. Just maybe give us a little bit of thinking on that.
So it's unfortunately, it is an area that bounces around depending on certain types of expenses or costs that we typically may not push down to the platform. So there is some timing that happens. So this quarter we were down roughly what $10,000,000 to $11,000,000 in the 4th quarter. We're slightly up versus last year's Q1 due to some of the timing around benefit accrual. So it does bounce around.
I think this quarter, we were $25,000,000 I think that's pretty long term there, right? That is still an area that we are very, very focused on.
Okay.
Just add
long term there, right. That is still an area that we are very much looking to drive down further. But this goes back to integrated systems and doing things a little bit better from a process standpoint. And so what I'd say is we continue to move toward our enterprise IT systems and as we continue to improve our process and our operating models, we'll start to get even further improvements off this overhead cost. But this one is a very painful one for me personally.
Yes. Well, Scott, to that same end, if I might just sneak in this last question on the SG and A because I know that the corporate obviously affects that. So what we might not completely gain back in operating margin what we lose in mix in the second half of the year, but wouldn't it greater OE shipments imply a year over year percentage reduction in SG SG and A in the second half of the year? And what is your ultimate target for that number if it's for let's say this year, maybe even next year, whatever you can give us, not the 2022, just kind of what are you thinking on that number for this year in total?
Yes. I would say, I mean, our aspiration is 20%. And I don't think we will be there by the end of the year. And again, goes back to just this is taking longer than we thought with systems and your ability to drive more process better and improved enhanced processes. But I think we'll make progress as revenues continue to grow in the back half of the year.
We'll make progress in bringing this down, but we're not going to get to the goal of 20% this year.
No, no, I know that. I was just making sure that SG and A as a percent of sales because of maybe a little bit more OE in the revenue, that should naturally decline more, right?
Yes, it will come down as a percentage of revenue a little bit. Yes.
Yes. Thank you.
Our next question comes from Andy Kaplowitz from Citi. Please go ahead.
Hey, good morning guys. Nice quarter.
Hi Andy.
Scott, so 4 quarters in a row of aftermarket bookings over $500,000,000 I think one of the initiatives that you had right when you became CEO is really capture more of Flowserve's installed base. Is Flowserve beginning to do that at this point? And do you see good sustainability of maintaining or even growing off of this $500,000,000 of bookings a quarter run rate?
Yes. No, I'd say it's a really good point. And I'd say one of the differentiating factors of Flowserve and the peers is that we do have just an incredibly large installed base. And so this is something that we've got a major initiative and effort within the transformation. We talked about this in December at the Analyst Day, and we're calling it commercial intensity.
But essentially what the commercial intensity initiative is, is looking at a local geographic site that might have 2 or 3 refineries and a petrochemical facility and how does our local team and that local quick response center start to get more of our installed base and capture our entitlement to do the aftermarket. And then the other thing that we're doing is we're starting to add services and moving up the value chain or the maturity curve of services. And so ultimately what we want to do is provide more holistic services and move from just providing parts and maybe a service call out here and there. And so I think all of that stuff is starting to come together now. We've rolled out commercial intensity worldwide.
So we're completed now through the Americas, our Europe, Africa and the Middle East business and then also in Asia Pacific. We are seeing really good results where we first started the program in North America and now we are just starting to see the benefits in Asia Pacific and in Europe. So as we continue to evolve that program and continue to get more mature, I'm confident that we can sustain this type of levels and continue to grow our aftermarket business. And then ultimately, as we move to reliability based systems and add more technology here, we really start to partner with operators, their maintenance departments, their reliability departments and providing a much more holistic service overall in our aftermarket offering.
That's helpful, Scott. And then could you give us a little more color into what happened with FCD bookings? Were the bookings relatively flash in the quarter? Was that all related to general industrial being weak? And we know you mentioned the oil price volatility impacting the general industrial business.
You mentioned that you expect to see a better North American upstream channel given higher oil prices. Have you already seen improvement in that end market yet? Have your customers really stopped destocking at this point?
Yes. So that was the challenge for FCD. And it was as you know, right, General Industries contains the distribution bookings. And so really that was the only negative spot in our FCD bookings was the North American distribution channel. And so as commodity prices went down in the 4th quarter, distributors stopped stocking and putting more product on their shelves.
And I think that's very natural. It happens all the time and we've got good visibility to their inventory levels. And so it says we had a little bit of warning and knew it was coming. Now what I expect is with oil prices back in a much better place than where we were at the beginning of the year, we should start to see completions and production in North America progress probably sometime late this quarter or in the back half of twenty nineteen. And as that activity increases, we'll see distributors start to spend money in stocking product on their shelves.
And where we get the biggest benefit the biggest risk is when does North American activity start to come back and do we start to put product back on their shelves.
Thanks Scott. Appreciate it.
Our next question comes from Jeff Hammond from KeyBanc. Please go ahead. Jeff, your line is now open. Can you check to see if you're muted? Okay, we'll go on to the next one.
And our next question comes from Joe Ritchie from Goldman Sachs. Please go ahead.
Thank you. Good morning, guys. Nice quarter.
Yes. Thanks, Joe.
On the POC disconnect in 1Q, the 6 percentage points that you referenced, how does that play out for the remainder of the year?
So Joe, this is Lee. My expectation, as we mentioned, tied to our bookings is that we should see more the way I would equate to it, we'll see more project revenue. And so during the balance of the year, there should be more project revenue than we had seen in the Q1. As you can tell from our variances, year over year our project revenue was down. We're expecting that to grow the balance of the year.
Yes. I guess maybe my follow on there Lee is when you compare it though to your Q2 to Q4 in 2018, do you still expect to see favorability in percentage completion accounting and how that impacts your margins? Or does that kind of net out because your project revenues
are ramping up throughout the year?
I wouldn't word it that way. I think what
I would say is that year over year, we're going to see more project revenue. I'm not we're not necessarily keeping a scorecard on like how much POC, but what I would say is that as we with our backlog, with our order wins in the Q1, we're going to have more project revenue in the second half of the year.
Okay, fair enough. And then my one follow on is really going back to the margins. Obviously, Recognize that there'll be, mix headwinds as we progress through the year on the project side. But like there's still just a lot of like goodness that you have going through the model right now from a margin perspective. And so I guess my question is, Lee, you mentioned earlier not to assume sequentially that margins would be better, but it would it seems like sequentially through the year, margin should be better in each of the businesses.
So I just want to make sure I'm not missing anything.
Yes. I just I think there's going to be some lumpiness from quarter to quarter. I think on a trailing 12 basis, it would be better. But I think it depends on how much project activity gets recognized in that quarter. So if we have a quarter where there's a number of large projects that go out, it could put some downward pressure on the rate.
Now on a trailing 12%, the point is that sequentially, you should see improvement. But I think like I said, quarter quarter, it could bounce around. It should be better year over year, but quarter to quarter there could be some lumpiness.
Okay, got you. Thank you.
Our next question comes from Joe Giordano from Cowen. Please go ahead.
Hey guys, good morning.
Good morning, Joe.
So just on the guide here, I mean, I know you guys are being very measured in terms of how you're publicly setting commitments and want to be very comfortable in your ability to be able to deliver on them, which I think we all appreciate. I just think forward from here with the understanding that 1Q is a low contributor to your full year, the midpoint of your guide is kind of 20% incrementals on the midpoint of your revenue guide, consider and we have very easy comps to like 2Q and 3Q on the old what's the old IPD. So can you just walk us through is that just conservatism and a little cushion there? Or how should we think about incremental? I mean, you were up obviously a lot on the revenue decline in this order.
So if we're expecting growth in the next 9 months, it seems like a fairly easy bar to get to.
Yes. No, Joe, we understand that we've done all the math and you've had a lot of discussion on this. But I just for us and where we made the decision is we're still very early in the year. And so we're pleased with what happened in the Q1 and we're focused on meeting our commitments for the rest of the year. But there's still a lot to do, right?
I mean, we've got to execute on our transformation. We've got to continue to hold the margins. I mean, a lot of things have to go right for the next three quarters. And then the other thing is just I just want to remind you and others in December, we talked about at the Investor Day, right, we talked about the different phases. And the first phase we were in, which was all of last year's, was the stabilized phase.
And now we're very much in the transformation phase, but the stabilized phase wasn't that long ago. And so we're still concerned about potentially some surprises here and there, but we feel very good that the teams are making great progress. And we very much want to move into our optimized state. And so right now, we're very committed to what we said in our full year guidance. And then again, the full year guidance is 17% EPS growth year over year.
And so it's not a small task. And what I'd say is when we put guidance out, we want to make sure that we can absolutely meet that commitment. And that's what we're trying to instill internally here at Flowserve. And so that's what we're going to do externally. But we'll continue to reassess throughout the year and as things move and change.
But right now, we're sticking with the full year guidance we put out last call.
That's fair enough. And then if I can on the organic growth guide for the year, just considering the price increases that you put in, in December and you put in some new ones this year, how much of that do you think is price alone?
Yes. I think, I mean, we're not doing anything crazy on price, right? We're never going to get 5%, 6%, 7% price increase. So I would say it's a really small percentage revenue growth here. But what we are confident in is that the pricing increases that we're seeing is offsetting inflation, tariffs and any cost headwinds.
And so we feel very good about that. It's definitely a portion of our margin expansion story here. And yes, I think you could see that as we go forward.
If I could just sneak in one last one. Another competitor on the pump side this morning talked about their oil and gas funnel as kind of they've already won a bunch of these orders and like the funnel needs to kind of reshape here. And they're exposed slightly different than you and it seems like there's a bit of different color. So if you could talk about like the oil and gas funnel from here, what's kind of been has there been a lot of projects that you've passed because of the competitiveness that you've talked about? And how full does that pipeline look on the new projects?
Yes.
We actually feel really good about our oil and gas outlook. And as I said earlier, and as you know, right, we're more of a downstream focused company. And so we're highly focused to the refinery side, and we feel good about the outlook for the next couple of quarters in the refinery segment. A lot of that's driven by regulation changes and the move to cleaner fuels. And so that's moving very well.
As we talked about in the Investor Day in December, right, we launched the strike zone initiatives to get back into the midstream space. And so this is midstream pipeline primarily focused on the Americas, but obviously there's pipeline work all over the world. We're seeing incredible progress with the pipeline work. And so we know we're taking market share because this is an area that we didn't have any bookings in 2017 early parts of '18. And so there's still a lot of build out in North America on pipeline and our outlook for the pipeline in the midstream is incredibly robust into Q2, Q3 and Q4.
And then the other big piece here is LNG. And so we got a handful of LNG orders early in the Q1 and we're actually very pleased with what were able to bring in, but it's just the beginning of this LNG wave. And so there is a significant amount of LNG projects going forward. And for us, we've got a great valve portfolio that supports the LNG projects. In addition to that, we've got pumps that fit into that space as well.
And so when we talk about our power of a pure play initiative, where we're bringing our pumps, valves and seals together, the LNG market is one that we're absolutely focused to bring the whole portfolio of Flowserve together to capitalize on that. And so I think you'll see more LNG discussion from us as we throughout the year and into 2020.
Thanks guys.
Our next question comes from John Walsh from Credit Suisse. Please go ahead.
Hi, good morning.
Yes, good morning, John.
Hi. So once again, I can remind everyone's sentiment on a solid quarter. I wanted to follow on that discussion with orders and kind of think about, obviously, as we get here into the back half, you have some difficult comps, but it sounds like you're really excited about the midstream and pipeline and the opportunity on the LNG side. How would you kind of characterize the activity level if you had to put a number around it? I don't know if it's should we think about the orders as a 2 year stack or how do you think about that profile as we go through the rest of the year here, obviously, knowing that quarterly earnings can bounce around?
Sure. Just so let's just stay on bookings and orders. Again, we feel very good about the And so we like what we see. Our project funnel is bigger than it ever has. The concern would be on the MRO and predominantly the North America land business that has slowed down in the Q1 and it's more about when does that start to recover and get back.
But overall, our project outlook is substantially better than where it was last year. The initiatives with commercial intensity and the ability to capture more on the aftermarket state is we're doing that on the back of some tailwinds on increased maintenance and spending. And so I feel very good about our ability to kind of keep continue to grow and keeping a healthy number of bookings certainly into the Q2 and realistically throughout all of 2019.
Okay, great. And then maybe just a question here around the pump division. I think when you were first speaking about that combination, a lot of the synergies were kind of focused around bookings and kind of sales. Obviously, a very strong margin in the quarter. Curious if you're actually seeing any cost synergies from the combination as well?
Yes. So again, we talked about this in the Investor Day. And the genesis or the reason that we pulled them together was really focused on our customers and better platform. And so there are no silos, there's no barriers within the pumps platform now. And we're better positioned to manage the commercial operations, project management.
And now we're moving into kind of the manufacturing planning, the supply chain side, the product rationalization opportunities. And all of those things will start to drive cost product cost down and improve our productivity within the manufacturing. So I think there's more good things to come here in terms of driving cost out. We haven't really started that today and really the focus has been about really getting positive customer response and doing the right things for our customers. And then what I'd say is in the Q1 received incredibly positive feedback from a lot of our customers that we've got better communication, clearer accountability and then ultimately the better performance is helping there as well.
But I do think we'll continue we will get some costs and cost savings as we continue to integrate these two platforms and drive those activities forward.
Thank you. Appreciate the color.
Our next question comes from Brett Linzey from Vertical Research.
Just want to come back to free cash flow. I guess from your internal vantage point and maybe relative to plan, what line items came in better than you expected? And then as I think about the 65 $1,000,000 swing in contract assets and I think it was about a $40,000,000 in accrued liabilities, what's the big driver there? Just a little more granularity on those dynamics.
So thanks, Brett. So what I'm happy to say is like actually nothing came in as a surprise. I think for the first time we kind of actually nailed our cash forecast. So I think everything to Scott's point earlier, I think we're executing where we expected to be between the sales through net margin and also the working capital. So I would say nothing really surprised us.
I think it came in pretty what surprised us is that we came so close. And so that's a good thing. As far as the contract assets, I think it shows a change in behavior versus last year versus this year. Last year, I just the processes that were in place so contract assets are effectively WIP. And material was brought in now with a disciplined this year as it was last year.
So last year, I think in the call last year, we were really disappointed. We didn't think that we had a good handle on what was going on with inventory and we learned from that. And through the balance of the year, we're much more disciplined. Scott added to the organization, he put metrics in place, we're doing weekly tracking. And as we went into this year, we kind of ended the call on our last call that we were expecting to have much better control around the Q1, around the amount of material we're bringing in and getting the jobs out.
And that played out. The team did an outstanding job getting the contracts out and putting the discipline in place to make sure material wasn't coming in.
Okay, great. And then just specific to 2019, I mean a quarter, a little bit more than 3rd of the way through 2Q here under your belt. What's the expectation in terms of free cash flow for this year? Scott, I know you mentioned 20% as an aspirational free cash flow margin over time. But what's the market for this year as we progress towards that 20%?
Let me answer it a little different. We got beat up around our free cash flow conversion. I think we were under 50% last year, and
I think Dean is one
who always beats us up on that. And I think when I was on the call, I talked the question was what give a target and I said over 75% and I think that's still good.
Okay, great. Thanks.
Thank you, ladies and gentlemen. We have reached our allotted time. This concludes today's conference. Thank you for participating and you may now disconnect.