Welcome to the Flowserve 2018 First Quarter Earnings Call. My name is Christine, 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 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, Christine, and good morning, everyone. We appreciate you participating in our call today to discuss Flowserve's Q1 2018 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'll open up the call for your questions. As a reminder, this event is being webcast and an audio replay will be available.
Also note that our earnings materials do, and this call will, include non GAAP measures. You can review the reconciliation of our adjusted metrics to the reported results prepared in accordance with generally accepted accounting principles in both our press release and earnings presentation. Finally, this call and our associated materials also contain forward looking statements, which are based upon forecasts, expectations and other information available to management as of May 11, 2018. These statements involve risks and uncertainties, many of which are beyond the company's control. And except to the extent required by applicable law, Flowserve undertakes no obligation and disclaims any duty to update any of these forward looking statements.
We fully encourage you to review our Safe Harbor disclosures contained in yesterday's earnings materials, which are available on our website at flowserv.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. We appreciate you joining today's call. Flowserve's Q1 financial results were in line with our expectations and provided a solid start to the year. I am pleased that we booked and delivered a high level of aftermarket activity and ended the quarter with a total book to bill greater than 1. We also continued our journey to reduce complexity, accelerate growth and streamline Flowserve's operating model for the future.
Before updating you on our Flowserve 2.0 activities, let me start with the financial update. In the Q1, we delivered adjusted earnings per share of $0.27 on sales growth of 6.2%. As I mentioned, these results align with our expectations and guidance. Aftermarket revenues accounted for 50% of our total and were up 11% year over year and aftermarket bookings were up both sequentially and year over year. We're also pleased with our solid and broad based total bookings this quarter of 929,000,000 dollars driven by growth in our general industries, power and chemical markets.
As you will recall, in the Q1 of 2017, our bookings included an $80,000,000 refinery project award, which skews the year over year comparison as we did not have any large project awards this quarter. Additionally, we sold 2 businesses in mid-twenty 17 that are included in the 2017 Q1 comparative results. Turning now to our segments. IPD's turnaround showed modest progress in the Q1, but we expect to gain further traction and achieve improved financial results as the year progresses. In the quarter, we delivered revenue growth of 11% year over year, which helped drive an improvement in adjusted gross and operating margins of 40 basis points 120 basis points respectively.
Reducing past due backlog from the current elevated levels remains a priority. The shipments of this lower quality backlog will present margin headwinds as it's delivered throughout 2018. However, I am confident in the IPD leadership team. They are aggressively driving actions to improve the overall operating performance of the platform. We continue to expect to exit the delivering mid to high single digit adjusted operating margins for IPD as improvements take hold throughout the year.
At this level, we still will not be delivering to our full potential and I remain optimistic in the longer term profile for this business. EPD also delivered double digit revenue growth in the quarter compared to the prior year. As Lee will discuss, adoption of new accounting standards accelerated recognition of some lower margin original equipment revenue, which more than offset the 10% increase in aftermarket activity. As a result, adjusted gross and operating margins in EPD declined 90 basis points and 50 basis points respectively. We are committed to improving EPD's manufacturing performance on original equipment products, which will include a number of facility closures this year to better leverage our highly engineered capabilities.
FCD achieved its highest dollar value of bookings since the Q4 of 2015. On a reported basis, the segment's revenue declined 1% in the quarter as a result of the non core business divestitures we completed mid last year. Excluding these divestitures, FCD would have realized revenue growth of approximately 8%. The segment's adjusted gross and operating margins declined 260 and 220 basis points, respectively, year over year. The decline in margin was primarily a result of product mix and timing.
I am confident this is a timing issue and not indicative of a trend. FCD has consistently delivered solid operating performance and we anticipate that full year 2018 will be no exception. I want to provide a little more color on our bookings and end markets. While we received no large products projects in the Q1, we did win a number of $3,000,000 to $8,000,000 awards driven by our base or foundational business. This solid performance helped partially offset the impact of the tough prior year comp, which included divested businesses and the large refinery booking.
Additionally, based on our improved visibility and solid quoting activity, we are optimistic about our near term market environment and believe we can deliver sequential bookings growth in the Q2. Furthermore, with the cycle turning, we are determined to begin recovering some of the industry wide original equipment pricing declines occurred in recent years. Since the beginning of the year, we have initiated 2 price increases on our base business to help improve margins, offset cost increases and mitigate the impact of a changing and dynamic global trade environment. Additionally, we have moved our margin threshold higher in our EPD original equipment business to begin the margin recovery journey in this platform. We believe this pricing discipline and approach will deliver value for our shareholders over the long run.
Our aftermarket franchise has proven resilient throughout the cycle. In the Q1, we delivered aftermarket bookings of $482,000,000 our highest level since the Q3 of 2015. Our discussions with customers continue to suggest they are increasing focus on improving efficiency within their facilities, indicating the potential for increased turnaround activity and the return of smaller project and upgrade investments. Turning now to our Q1 bookings by end markets and starting with oil and gas. Bookings decreased approximately 19% year over year driven by challenging comparison due to the EPD large refinery award in 2017.
SED's bookings were up modestly, including enhanced onshore North American activity, while IPD decreased by approximately 40%, also driven by a challenging comparison. A number of run rate awards in EPD and IPD, primarily in Asia Pacific and the Middle East, coupled with the improving commodity price indicate improved conditions for oil and gas markets. Our confidence is supported by the strong pipeline of pre feed and feed activities that has continued to expand. Our bookings increased approximately 3%, driven by FCDs and IPDs low double digit growth on short cycle activity, while EPD declined approximately 9%. Overall, chemical demand continues to grow globally, driving additional ethylene investments in Asia, the Middle East and North America, where the second wave of the crackers continues to move forward with 3 projects now in E and C hands and several others in various stages of planning.
Flowserve's power bookings increased percent year over year driven by strong performance in EPD and IPD and included nuclear awards in Asia Pacific and a desalination project. Power industry is the most challenged industry that we serve and we are not counting on significant near term growth in this space. General industry bookings increased over 17%, driven by strength in EPD and FCD and a modest increase in IPD. The increase was largely driven by distribution, including strength in Asia Pacific, Europe and the Middle East. From a geographic perspective, we had strength in the Middle East and Africa, delivering 15% Due to large refinery award last year, Asia Pacific was down 13%, while North America and Europe were also down by low single digits.
In summary, while we expect our markets to be somewhat choppy quarter to quarter, we continue to believe the multiyear downturn in the cycle has started to reverse course, and we anticipate an improved marketplace ahead. We believe global economic conditions are supportive. Oil prices have shown stability at higher levels. The tax reform package and regulatory environment are beneficial in the U. S.
And the global project pipeline is growing. While we remain disciplined and realistic in terms of our outlook, we do anticipate solid steady growth in our markets and we expect to see sequential growth in the 2nd quarter. We believe the combination of improving marketplace and our internal initiatives that we are taking to strengthen and transform the company will position Flowserve to deliver value for our customers and shareholders. I'll now turn it over to Lee to discuss our financial results in greater detail and then I will turn for a few comments before we open the call to Q and A.
Thank you, Scott, and good morning, everyone. As Scott mentioned in his comments, at the start of the 2018 Q1, Flowserve implemented a new revenue accounting standard ASC 606. From a Flowserve perspective, implementation of this new standard had numerous moving parts, primarily due to the significant increase in contracts requiring percent of completion accounting, also referred to as POC or overtime. While I don't intend for this call to become an accounting lesson, let me highlight some of the significant changes. We implemented ASC 606 under the modified retrospective approach.
Under this methodology, certain contracts which have remaining obligations as of the effective date are recognized and retained earnings at January 1, 2018. The impact on Flowserve is that $237,000,000 of year end 2017 backlog equating to $0.15 of EPS was recognized and retained earnings under the new standard. With 23% of our revenues this quarter now coming from contracts under a percentage of completion compared to just 3% in the Q1 of 2017, The new standard increased our revenues recognized this period as compared to the former standard. These POC revenues of $71,000,000 were primarily timing related and were dilutive to our reported gross profit margin since most related to larger OE projects. Since very little SG and A was applied to the incremental amounts, the revenue was modestly accretive to our operating margins and our EPS.
Our balance sheet now has 2 new line items called contract assets and contract liabilities that are essentially for our projects and process. The amounts in these new categories came primarily from what previously would have shown in receivables, inventory and accrued liabilities. To wrap up this topic, let me reiterate that we knew this new accounting standard was coming, so our expectations and guidance were based on it. It was a major accounting effort due to the number of contracts affected, new locations doing POC for the first time, the multiple ERP systems that exist within the company and most significantly that closing the books and reporting using both the new and prior accounting standards. I am proud of our team for getting this done.
We do expect however that our financial reporting will occur a little later in the cycle for the remaining period this year, similar to this quarter's timing. Let me now return to why we're here, which is discussing our financial results for the quarter. Flowserve delivered adjusted earnings per share of $0.27 Again, very much in line with our expectations we discussed on our last call and the guidance given. On a reported basis, earnings per share of $0.12 included realignment expense of $0.07 and $0.05 of below the line currency impact and $0.03 of discrete corporate items. 1st quarter sales increased 6.2% to $920,000,000 In addition to the new accounting standard, we incurred roughly a 2.5% headwind as a result of the divested businesses Scott spoke about earlier, which were offset by approximately 6% of currency tailwinds on the weaker U.
S. Dollar. Aftermarket sales increased 11% to $455,000,000 representing 50% of our total revenue for the quarter. Looking now at our gross margins, our adjusted gross margin of 30.3% was down 130 basis points versus the prior year's Q1. Lower margin original equipment revenues, including the impact of the new revenue recognition standards, more than offset our incremental cost savings and a 300 basis points mix shift toward higher margin aftermarket activity.
On a reported basis, which included increased year over year realignment charges, our gross margin decreased 160 basis points to 29.5%. Adjusted SG and A was basically flat in the Q1 as our continued incremental cost savings initiatives largely offset the impact from the weakened U. S. Dollar. As a percentage of sales, adjusted SG and A decreased 110 basis points with improvement across all segments.
Reported SG and A increased due to the currency headwinds despite cost efforts and lower realignment spend. 1st quarter adjusted and reported operating margin declined 30 basis points and 100 basis points to 6.8% and 4.9% respectively. As Scott discussed, we delivered modest improvement in IPD's adjusted operating margin which were offset by FCD's 220 basis point decrease as a result of timing and shipment mix. You will note, we are no longer adjusting for IPD's PPA related to the CEH acquisition, where no tax benefit was realized. On adjusted basis, the effective tax rate for the quarter was 27.5 percent which is in line with our full year expectation of 27% to 28%.
Turning to cash. Although our total operating cash flow was a use of $121,000,000 reflecting traditional seasonality, our cash balance remains strong. We finished the quarter with over $500,000,000 of cash and cash equivalents, more than $200,000,000 above March 31, 20 17. In the Q1, we returned $25,000,000 to shareholders through dividends and had capital expenditures of $13,500,000 down about $2,400,000 from a year ago. While the Q1 tends to be a seasonally weak, as I discussed before, our working capital performance is still not where it needs to be and it remains a priority to reduce.
In 2018, the company is focused on implementing sustainable improvement to its working capital processes. We're changing the foundation of all aspects of our order to cash and sales and operational planning processes. We expect the initial benefits of these changes to begin being recognized in the second half of the year. Looking forward, our clear expectation is to deliver stronger cash flow performance. Turning to our 2018 outlook.
With our Q1 results in line, which kept us on pace for the full year, we reaffirm our full year EPS target range of $0.95 to $1.15 per share on a reported basis and $1.50 to $1.70 per share as adjusted. We also confirmed our expected revenue growth of 3% to 6%, including a 2% full year currency benefit and a roughly 1% negative headwind from last year's business divestitures. The adjusted EPS target range excludes the 2018 expected realignment and transformation expense of approximately $90,000,000 as well as below the line foreign currency effects and the impact of potential other discrete items which may occur during the year. Both the reported and adjusted EPS target range assume year end FX rates and commodity prices, current backlog, expected booking levels and market conditions and a minimal impact from the adoption of the new accounting principles as new awards coming in are expected to offset the lost backlog. Net interest expense is expected in the range of $58,000,000 to $60,000,000 with a tax rate of 27% to 28%.
Additionally, we expect traditional earnings seasonality although for it to be more pronounced in the second half of the year. We also expect to use approximately $100,000,000 of cash in 2,008 to pay dividends to our shareholders. We will remain disciplined in capital expenditures, but plan to invest in some enabling technologies for Flowserve 2.0, which should bring full year CapEx to the $80,000,000 to $90,000,000 range. We expect to pay down approximately $60,000,000 in debt and contribute approximately $30,000,000 to our global pension plan, mainly to cover our ongoing service costs as U. S.
Plans remain largely fully funded. Now, let me turn it back to Scott for his closing remarks.
Great. Thanks, Lee.
I'll conclude the call with an update on our internal initiatives designed to transform our business model to better serve our customers, engage our associates and reward our shareholders. We call the initiative Flowserve 2.0 and we're taking the best from our past, improving on it for the future. In the February call, I discussed the initiative in some and highlighted our recent completion of a full scale internal assessment across 6 key areas: operations, commercial, growth, aftermarket, G and A costs and working capital. Since that time, we've gone from assessment to now taking action. It is still early days, but we have now formed a fully dedicated transformational office with some of Flowserve's brightest associates.
We are augmenting this team with third party expertise where needed. The singular focus of this group is to accelerate and drive sustainable and value creating change to improve our operating model. We're changing the way we think, act and operate to better drive growth and reduce costs. The Transformation Office is currently focused on scoping and sequencing different initiatives that are intended to ultimately reduce the complexity of Flowserve, better leverage our enterprise scale and accelerate growth. These projects fall under broad work streams that are underway in various planning stages.
Here are some examples of what we are attempting to do. Improving our focus on select core markets, developing a methodical process to set and govern pricing decisions, rationalizing product lines and employing design to value principles, improving efficiency and effectiveness of our selling functions, driving operational excellence and consistency across our global manufacturing footprint to reduce lead times, improve on time delivery and reduce our non material cost of goods sold optimizing our supply chain activities across the enterprise to reduce material cost driving increased growth and profitability across our aftermarket platform, structurally reducing G and A costs while improving efficiency and effectiveness, driving to common operating systems and process automation tools and becoming a people first organization that embraces a common strategic mission. As I said before, transformational change like we're pursuing is not easy or accomplished quickly. We're not trimming around the edges, but we are pursuing a comprehensive change to our business model that will deliver long term benefits to our stakeholders. I am confident that these actions will increase our ability to effectively support our customers, create a more meaningful workplace for our employees and drive significant long term value for our shareholders.
Operator, that concludes our prepared comments. We'd now like to open the call for questions.
Thank Our first question is from Mike Halloran of Baird. Please go ahead. And Mike, if your line is muted, can you unmute your phone?
Martin, Mike, are you there?
We'll move on. The next question is from Charley Brady of SunTrust Robinson Humphrey. Please go ahead.
Hey, thanks. Good morning. A couple of questions here. Just on FCD, can you just elaborate a little bit more on the timing issue that impacted Q1? And as kind of a follow-up to that, in line with that, as you're looking towards your visibility, you comment that you expect sequentially improving bookings in Q2 from Q1.
Is that confidence a function of what you've seen bookings through April May? Or is it just more of quotation activity that you think hasn't hit yet, but likely will? Yes.
I'll let Lee do the SDC margins, and then I'll take on the outlook on bookings.
Yes. So, hey, Charlie, this is Lee. FCD had a record 4th quarter, finished the year and a lot of that performance pulled some of their shipments from the Q1 into the Q4. So they basically performed as expected and I think a lot of the results of this quarter were really impacted due to their strong Q4.
Yes. I'll just say, I think to add to it, we've got a very strong FCD team. We're confident that that starts to get back into a more normal operating margin level. On the Q2 bookings, we feel pretty good. So we had a solid April bookings and we've got visibility to refining and petrochemical work in the near term.
And we've got clear line of sight that we believe that Q2 is going to be higher than Q1.
On those ethylene plants that you mentioned that have gone to the 301s have gone to EPCs, are you on those plants yet? Has the equipment been awarded?
Some have and we're participating and others are still in the pipeline.
Thanks. I'll hop back in the queue.
Thank you. Our next question is from Andrew Kaplowitz of Citi. Please go ahead.
Hey, good morning, guys.
Hey, Andy. Good morning, Andy.
Scott, so when you think about Flowserve 2.0, can you give us an update? Obviously, I think last quarter you talked about at some point setting out official targets. You talked today about improving efficiency in the factories, optimizing the supply chain among other things. But is it are you ready at some point to give us a timeframe of when you think you might able to be able to say that the company is more simplified? And how do you think investors should judge you on Flowserve 2.0?
Should we see meaningful improvement in performance by the end of this year?
Sure. Yes, I think the best way to think about it, I said a little bit in the prepared remarks is that the way we're using Flowserve 2.0 is it's the vehicle to accelerate our transformation. We're not satisfied with the performance of the company, both operationally and financially, and we know we've got to do things differently. And as I kind of worked through the back half of last year, it was what was we had to do something as a catalyst internally to start to drive significant change. And so that's why we've created this initiative.
And as we talked about, we did a very holistic assessment in the that launched in the Q4. It completed in the Q1. And just basically where we are, that assessment is now completed. We staffed this transformational office here with a pretty large number of associates at the your dedicated Flowserve associates that are leading that transformation. We've got the 6 work streams that I commented to on the script.
So we've got commercial, growth, aftermarket, operations, working capital and then our cost structure, G and A cost. And then we're augmenting that team with 3rd party help where we just don't have the skills or the talent or we can't assess best practice to bring into Flowserve. And I would just say the potential sequence. And we recognize that this is a significant effort with massive process improvement and it's driving success and change for the long run. The majority of the prize will be 2019 and beyond, but we fully expect to start to see benefits and achieve results in the back half of twenty eighteen.
It's going to continue to require investment in our people, our process and our systems. And while we would love to come out and say, here's the potential of Flowserve and here's the prize, I just think at this point, we're not ready to do that. We're still sequencing things. We're still committing to actions. And quite frankly, I want to get some wins under our belt and get some traction and get and get more confidence in the program here.
But I do think at some point we'll need to talk about what we see as the holistic potential for Flowserve. But I think right now it's more of a milestone story and it's let's get a win or 2 under our belt and then we'll come out holistically with the program, the actions and what we think is the kind of where we think Flowserve can go on some high level metrics.
Scott, that's helpful. And then either for Scott or Lee, we know the Flowserve, I mean, you mentioned that you usually have seasonally weak free cash in the Q1, but negative $134,000,000 And the problem is rev rec, I guess, muddies the waters a little bit, but you had a $64,000,000 increase in contract assets. So can you talk about revenue in excess of billings, why it's higher in the quarter? And maybe talk about the second half improvement that you expect in working capital. If we look at the numbers, working capital as a percentage of sales were 27.9% last Q4.
Should we see better than that by the end of this year? And how should we look at working capital itself?
Yes. So the accounting clearly has changed the formula a little bit. One thing that I should mention in contract assets, that represents cases where we have not billed the customer for the work that's performed. So included in that, there is some profit that is part of the adjustments that we disclosed in the Q. But just stepping back, we made tremendous progress in the Q4 in driving working capital performance.
Unfortunately, a lot of it was just it was very manual and a lot of, I would say, management intensity. Coming
out of
the year and in the Q4, trying to get the Flowserve 2.0 running, trying to get the new accounting running, We could not provide the same, I would say, management intensity around all these areas. So working on AR, we did not make as much progress as I would like. We're in the process of putting in more systematic fixes to drive that and understand what's preventing us from getting collections. On the inventory side, as we talked about in the last call, we've been working hard and driving our past due backlog performance. We did not make as much progress as we would have liked and that's providing some overhang.
And then I guess the 3rd part I would highlight is that in Scott's remarks and my remarks, we talked about building our what we call our S and OP processes. That is a major change from how the company historically has been run. And we're in the process of implementing the right processes around forecasting, buying inventory and executing production. And so that's going to take some time during the course of the year. Scott has added individuals who are extremely skilled in these areas, but it's taking time to start to get the pilots running and starting to institutionalize that effort.
So in a nutshell, we're not pleased how the Q1 played out, but we feel that we can turn the corner and drive improvement through the balance of the year.
Yes. I think just to summarize, what Lee said is, we're not happy with where cash flow and working capital are. We've been doing it a little bit by brute force and management attention and we're turning that now into a much more elegant systematic approach that's systemic and can drive long term results on this. And so we're adding resources. It's a major part of the Flowserve 2.0 and we do expect see progress here in the back half of twenty eighteen on working capital.
Okay. And we had just clarified one thing. You had $0.03 I think of benefit from ASC 606 in the Q1 and you said it was timing. Does that mean that that impact sort of recedes as the year goes on? Any more clarity there and how to think about it in the rest of the year?
So in our guidance, we said adjusted 150 to 170. Dollars Through ASC 606, we effectively lost $0.15 from the restatement that went into retained earnings. What we've got out and what we communicated is that we believe that's going to be other pull in from 2019 into 2018. So net net, we don't think there's any impact. Where there is potentially some impact is timing during the year.
And so it was difficult to figure out when how this is going to get sequenced. But we feel that for the year, the $0.03 effect that we got this quarter is going to be offset in other quarters. And over the course of the year, it should be balanced.
Thank you. Our next question is from Scott Graham of BMO Capital Markets. Please go ahead.
Hey, good morning.
Yes. Hi, Sean.
Hey. So in EPD, could you unbundle the bookings there a little bit some of the commentary you made, Scott? Was oil and gas and EPD down because of the comp? Or when you remove the comp, was it still down? And why was chemical down?
Yes. So on EPD OE specifically, we had the large comp, the $80,000,000 award in refinery or oil and gas in Q1 last year. If you remove that oil and gas was actually up slightly, when we look at kind of apples to apples excluding that. And then on the chemical side, I don't know, Jay, do you have the exact number on the year over year on chemical?
Sure. No, the chemical bookings were actually up on a dollarized basis. They were down slightly on a constant currency basis. And I would suggest that it is predominantly timing because as Scott mentioned during his prepared comments, we are fairly optimistic about the outlook for chemical going forward. And then,
Scott, I would say just more generally, we're not really excited about where the OEE pump bookings were in the quarter. There was a lot of work out there. And so we've got to get a little more rifle shot approach on these things. We do have visibility to a much stronger Q2 and so we're looking forward to that. But also just especially on the EPD side is, I said this in the prepared comments, but we ratcheted up our margin expectations probably at the end of Q3 and Q4.
And what we saw is those kind of tenders went through the cycle and started to materialize in Q1. We probably overshot a little bit on pricing. And so we know we've lost some work in Q1 that we potentially could have won had we not been pushing that. And so we're continuing to look at pricing. But also we also feel strongly that this business commands and should get higher pricing than what's out there today.
And so we're going to be pretty disciplined about what we take into the system and make sure that what we take, we can generate the value that we deserve in these awards.
Got you. Thank you. Just a follow-up on the Flowserve 2.0 and I'm going to maybe make some phrases up here. I'm assuming that of the 6, some of it is like closer of 2.5 and some of it is closer of 1.5. And by that I mean, all 6 don't have don't require the same level of intensity by the company and you guys in that room.
Could you kind of tell us of the 6, maybe which 2 or 3 are areas where you have to be more intensive and maybe which ones maybe a little bit less? I'm assuming that working capital is on the more 2.5 side. But you see where I'm going with this question because the old Flowserve had some things wrong with it, but a lot of that stuff happened in the last couple of years when the markets went really bad on them.
It seems to me that there's some
of these areas where they're not as bad as others. Maybe you can kind of lay some of that out, Scott.
Sure. I think I'm not going to use your 1.5 and 2.5 because that's going to confuse all of my 70,000 associates here. So what I would say is that obviously there's different intensity across the 6 initiatives. But I'll just go through it. But clearly aftermarket sorry, let me start with working capital.
Working capital has got to get significantly better. And so that's an area that we've already added resources and we're moving into systemic process change. Under operations, supply chain is another significant area of focus. And so we go back to the problem statement, you've got originally lots of different acquisitions, sites basically made a lot of decisions and we're not leveraging the scale that we have at Flowserve. And so supply chain should really as we start to consolidate our supply chain centralized process, we should be able to get some nice wins here this year and that's a big prize if we can do it correctly.
And then the third one that I would say would be on kind of the top three list of value creation immediately with a little more intensity is aftermarket. And so while the aftermarket franchise is absolutely fantastic, right, and I continue to be impressed with our breadth, the Seals business and kind of what we can do. If I look back over the last 3 years, we haven't really grown aftermarket in the way that we need or should grow it. And our installed base continues to grow and yet we've been relatively flat on aftermarket. And so one of the big areas that's getting a lot of initial attention and focus is how do we really start to unlock and grow the aftermarket more than we have here in the last couple of years.
So I'd say those are the 3 areas that are coming with a lot of intensity and we expect to see relatively quick rewards in the back half of twenty eighteen and early twenty nineteen. But all six are critical and we'll have actions and initiatives that we have leaders across each of those work streams.
Understood. Thank you. And if you could just maybe one quick mention on when you expect to start announcing the plant closures? Thanks.
The plant closures, is that correct? Yes. Yes. So we've actually we announced some in the Q4 and we announced 3 here in the Q1 of this year. And so that is ongoing and kind of I'll just say generally on the restructuring, right, we haven't changed our course there.
We do expect to complete largely the original program at the end of this year. But we added a few in the Q1 that weren't part of the original program. They were relatively smaller, I would say, as cleanup that was desperately needed. And we did announce those in the Q1. So we're still continuing to press this.
We believe from a capacity footprint.
Was that a news release or is that an internal announcement? Because I apologize if I missed that.
Yes, just internal, we're not we don't do that externally.
Got you. All right. Thank you.
Thank you. Our next question is from Steven Fisher of UBS. Please go ahead.
Thanks. Good morning.
Hi,
Steve. You guys explained the timing part of the FCD margin with the pull forward. Can you just give us a little more color on the mix headwinds you experienced? And when do you think you'll see the FCD margins return to improving year over year?
So this is Lee. So the key issue in the Q1, like I said, is we moved a lot of, I would say parts and services got really pulled in into the Q1. Like I said, we put a lot of pressure on them to deliver and they exceeded our expectation. My expectation is going to the second, third quarter, we should start seeing those margins going back to where they historically been.
Okay. And then in achieving your IPD margin targets, to what extent is this going to be more a result of gross margin improvements versus lower SG and A? I'm not sure if past backlog, past due backlog, is that just directly a gross margin thing or how should we think about that dynamic?
Yes. The progression on IPD is primarily on the gross margin line. There will be some SG and A savings and work there, but it's really around execution performance. And so we've talked quite a bit about the pain in IPD and some of the sites that are causing us concerns. Those now have a pretty significant past due backlog.
And what I would say is in the Q1, they did not get worse. They didn't get significantly better, but we're in a stability mode right now. And so we've kind of stabilized the platform, if you will, and now we've got to really start to transition and focus on optimizing it for the future. But I think you'll start to see the improvements more on the gross margin line and we do feel confident that we start to make progress in the second Q3 of this year.
Okay. And on the past due backlog, should the ultimate target for that be 0? And if not, why not?
Yes. So it will never be 0. And really it's a balance of our commitment to our customers and lead times. And so in an ideal world, right, you're running a past due backlog at kind of a 2% to 3% of total backlog. But probably what's more importantly is that we're focused on our lead times and getting those as short as possible.
And then when we make a commitment to our customers, what we don't want to do if we miss a delivery, we want that the days late to be 1 week or maybe 2 weeks. We don't want the days late to be months or even quarters, which is kind of some of the situation we're in today. And so passenger backlog will always be there, but it's going to what we want to be doing is driving lead times down aggressively and really tightening up our variability and our ability to execute.
Okay. Thank you.
Thank you. Our next question is from Joe Ritchie of Goldman Sachs. Please go ahead.
Thanks. Good morning, guys.
Hi, Joe. Good morning, Joe.
Maybe just sticking on the past due backlog for a second, is it do you guys have like liquidated damages that are going through at all or is this just a function of just extra cost to serve? Is that I'm just trying to understand what's going through your margins right now?
Sure. Look, delivering late is not good, right? It causes concerns with customers, it's revenue, it's working capital. We do have liquidated damages. There's receivables and collection issues, inventory.
So it is bad. And so you don't want a large past due backlog. And so what I would say is we didn't have any major surprises in the quarter, but we didn't bring down working or we didn't bring down that past due backlog in Q1 and it grew. And IPD was relatively flat, but it grew in both EPD and STD. And we've got a we're continuing to focus on operations and our performance to drive that down.
And one of the things and Lee touched on this is, we've got a lot of issues there, but one of the big things that we're really focused on or focusing on is manufacturing planning. And so we're introducing the S and OP process. We're investing in production planning and material management, which quite frankly are just basics to manufacturing. But if you don't do these really well, then you get a lot of the issues that we're facing today. And so this is under the Flowserve 2.0 and we've already added and strengthened our competency and our people in that space.
But it's an area we've got to get significantly better at.
Joe, one thing I would add to that is when we identify liquidated damages or the potential for liquidated damages, we record them once we realize that, that product is going to be late. So we did not necessarily incur a bunch of liquidated damages this quarter because a lot of the timing of shipment was known last quarter and the quarter before.
Got it. That's helpful, Jay. And I appreciated the color on that as well, Scott. Scott, maybe just we've talked a little bit about the organic bookings being down year over year and why they were, but they were also down sequentially. And I know that there's an expectation for a sequential improvement in 2Q.
But I take a step back, I look at the oil backdrop right now, it's very strong. I guess I'm wondering like when can we get back to $1,000,000,000 per quarter in orders, just given that the backdrop has strengthened? And then secondly, do you guys have the right capabilities in place today to actually deliver on that kind of backlog? Or is it going to take some time to fix things internally before you would take in those types of orders?
Yes. So we did come down sequentially. What I would say is the FCD grew and had actually if you exclude the Jester divestiture, we were up 15%. We had 482 on aftermarket, a really good number. And so we had some bright spots in the quarter.
We had a hard comp year over year with the Hingley Award and some of the divestitures. But no, I think everything we're doing is focused around growing and we would really like to see $1,000,000,000 on the top line at the quarterly level. And that's kind of what we're lining up and focusing on from a sales team and execution strategy. And I don't know if we're going to get to $1,000,000,000 but we do have confidence that the Q2 will be higher than Q1. And then just on the ability to execute, what I would say is, we're being back to planning and understanding where our capacity is and where our problems are.
We're being more deliberate about making sure that the work that we do bring in that we can actually execute and deliver throughout the system. And so a lot of the past due backlog we do think is starting to clear and we're being selective as where do we put that work and which facilities and making sure that we can execute. So I'm confident that what we're chasing today, we will be able to execute, but we've got to continue to progress our operational capability.
Got it. And maybe if I could sneak one more in for Lee. Lee, how should we be thinking about cash flow then? I know you guys don't have like a cash flow guidance for the year, but did the accounting rules change anything? What should be the expectation from either free cash flow generation or conversion for you guys?
So the new standard does not really impact cash flow. It just it obviously puts it in different buckets. So our expectation is that we are driving down working capital. We are improving the velocity of receivables, velocity of inventory. Under the new accounting, some of what used to be an inventory analysis and contract assets.
So
we need to come up
with some better metrics around that. I mean, we're still getting comfortable with just how the accounting work. But we need to drive more transparency around how quickly are things going through the facilities and how well we're collecting. But again, the accounting doesn't impact cash, but it does put it in different balance sheet accounts. And the expectation is we're going to reduce our investment in working capital.
But
our investment in working capital. But do you guys have like a bogey? You have to have at least an internal bogey that you'd to hit from a cash flow perspective for the year, I would think.
Well, we've not gone out with cash flow guidance, but the expectation is that we're driving improvement in operating cash flow year over year.
Thank you. Our next question is from Jeff Hammond of KeyBanc Capital. Please go ahead.
Hey, good morning, guys.
Good morning.
Just on the, I guess, on the order pacing, one, can you just talk about what you're seeing on pricing? What you're doing differently as you get a better environment to drive price? And then just comment on how the funnel is starting to build or visibility is building for larger projects?
Yes. On pricing, I talked a little bit on the prepared remarks. We did come out at the beginning of the year with a very general price increase on certain industry items. And then in the end of Q1, we followed that with a much broader price increase on the back of steel import tariffs. And so we've got 2 out there this year.
I would say the second one is a little too early tell in terms of traction and making sure that that's going to work. The other thing that we did was on EPD specifically. So EPD OE is we did ratchet up our margin expectations. A lot of that work is a cost plus model rather than a list price. And we did that in the Q3 Q4 of last year.
And what we saw is we had mixed results. And so our bookings probably could have been higher in Q1 had we been a little less aggressive on that pricing. And so we're kind of feeling our way through what we believe should be increased pricing environment, but yet we're struggling to get that traction. But we do want to be on the front side of this and be a leader in price. And given some of the operational challenges that we talked about before, we want to make sure that we're a little bit more selective.
We bring the stuff that we can work on. And when we do it, we actually get rewarded for the work that we do.
And then larger project visibility?
Yes, larger project visibility, I would say our funnel of projects is probably better than I've seen in the last 12 months. On the larger ones though, we're not seeing anything at that kind of large size at the $100,000,000 where we had 1 or 2 last year or in the last 12 months on. But we're seeing a really healthy pipeline at kind of that $10,000,000 to $20,000,000 range. And so I would expect to see more of those in Q2 and Q3 and as we complete the year.
Okay, great. And then just back on past due backlog.
So I think you said
it was stable this quarter. And I just I want to kind of get back to the big gating factors of kind of making improvement, particularly as you start to get a pickup in demand like that you can kind of continue to make progress? Thanks.
Yes. So I'll just I want to be super clear on past due backlog. So IPD was reasonably stable in the quarter. Where it went up was on the FCD side and the EPD side. And so we actually grew past due backlog in Q1, which is certainly not what we want to do.
And then in terms of fixing this, one, we talked about it, but we've really got to change and strengthen our competency around planning and manufacturing process improvement. And so that's the focus. We've got that within the Flowserve 2.0 umbrella and we're basically systematically going through large plans on ability to plan and execute our work. And so while Flowserve has had a lot of success historically, planning and delivery have never been a real strength. And so it's something that we're taking a very comprehensive look at it and making sure that we've got strong competency around planning and manufacturing execution.
Okay. Thanks, guys.
Thank you. Our next question is from Deane Dray of RBC Capital. Please go ahead.
Thanks. Good morning, everyone.
Hi, Deane.
Hey, I might have missed this, but I was hoping to get some color around the reference about 2 price increases that you've put through. Just what's the cadence of those? What's been the reaction of the customers? What kind of yield are you getting on that pricing? Just any color would be helpful.
Yes. Deane, I talked about a little bit. I'll certainly go into it again. We did one at the very beginning of the year. What I would say is on select items and it was discrete.
And we've got some data now that's saying that that was reasonably successful with a relatively nice uptake and didn't get the pushback or the losses is that we were worried about. And so that one went through reasonably well. The second one was on the back of the import tariffs on steel. And so we did that at the end of March and we're just too early to tell on that one. And so those are the 2 that have happened this year that are more across Flowserve generally.
And then just what I haven't talked about yet is price is something that we're very much looking at in the commercial work stream for Flowserve 2.0. And what I would say is, we really haven't utilized analytics to really drive more intelligent pricing decisions. And so that's something that we're absolutely jumping on and we think we've got opportunities on where we got like parts pricing, our aftermarket service pricing and in some of our more standard type products, we're making sure that we don't have disparate pricing and that we're able to move that up progressively and done with some logic and intelligence.
Got it. And then for Lee, how does this translate into price cost for the year? I don't think you've got a specific goal here, but where does that stand if you had to draw the line in the sand today on how you're tracking on price cost on a net basis?
Yes. So right now we're kind of assuming the 2 offset each other. We'll see how that plays out.
I mean Scott didn't go into
a lot of detail. Even on the cost side, we have a supply chain group that is we're looking at who we buy from, trying to consolidate suppliers, trying to be proactive on some of the inflation. So our assumption is that it's pretty consistent with the guidance. We assume there's going to be inflation and we also assume there's going to be some price and then the changes since being the year, we're assuming that net outs to be pretty consistent with what we assume that we assumed originally in our guidance. Got it.
Thank you.
From Joe Giordano of Cowen.
So Scott, on the pricing and the loss of maybe some work that's been out there, I guess, how strong is your stomach on this? How long are you willing to remain firm and sacrifice orders to kind of try to lead the market into a more disciplined scenario?
Yes, it's a good question, Joe. And it's something we talk about quite a bit between our Commercial Officer and our Platform President and myself. I think we went pretty strong hoping to get more traction than we did in Q1 and it's something that we're evaluating on a regular basis. And so I would say we're not going to be completely dogmatic and we're going to do it very rationally. We understand that we want to drive growth in the business and so we're not going to jeopardize that.
But at the same time, we're not going to take work that doesn't we're not going to take it for practice, right? We want to take work that we know we can make money on and we're very focused and committed to work that gives us a long term aftermarket annuity. And so I'd say we're getting much more methodical about our pricing and we've got a more deliberate and more visible planning cycle that allows us to have rich discussions early in the cycle and early in these project pursuits. Is it like We're not going to do anything crazy on this, right? I mean, we know it's a balance.
We've got some under absorption in some areas, but we've got past due backlog in others. And so we're pretty good about what we want to win and we're going to be more targeted.
Is this like a handful of bad actors just willing to do things for 0? Or is it or are you guys kind of an outlier with your thought process right now?
Well, I'm not going to say we're an outlier. And obviously, as you're bidding these large projects and tendering things, it's a pretty dynamic environment, right? So we'll get signals and we can move our price down as we need to. But what I would just say is, I mean, look, we've been 3 years in a down cycle. Everybody has excess capacity and I think folks were eager to fill their capacity.
And what we've said is, yes, we want to make sure we minimize our under absorption, but at the same time, we want to be the ones that are moving the market up here.
Okay.
And then on the past due backlog, I hate to keep bringing the same questions up, but I understand why maybe it didn't go down as much, but I'm a little why did it actually go up in EPD and FCD in this environment?
Yes. Good question. Again, I think systemically we don't have the planning and we don't have that true operational focus that we need. But what I would say is, in the quarter, it really was isolated to a very large project, 1 or 2 projects that we just didn't deliver on time. And the good news is these aren't going to be quarters late or significantly late.
They're probably in the range of a 30 to 60 day late. And so we do expect to clear some of this in Q2 and it remains a significant focus on us to improve our operational excellence.
And if I could just sneak one in for Lee, regarding EPD and SCD margins given 1Q performance, do you think that you could be up year on year for the full year in those two segments?
Yes, I mean that's our expectations. I mean I think again what I said a little bit earlier in my prepared remarks is some of the new accounting pushed down the margins. EPD would have been 160 basis points higher if we had used the old accounting. And so some of it comparing that to prior periods, it would have been a very competitive margin. So our expectation is to drive margins throughout the year.
But even like
using this structure that we're currently booking for 1Q, you think that it's still possible for those two segments to be up year on year versus what we booked for last
year? Yes. Okay. Thanks, guys.
Thank you. Our next question is from Robert Barry of Susquehanna. Please go ahead.
Hey, guys. I think for 2 more minutes, I can say good morning.
Hey, good morning.
Maybe another hour and 2 where you are. So I just wanted to pick up on the comments earlier about providing the long term targets. Scott, when you say you want to wait to get 1 or 2 under your belt first, like what exactly does that mean? Because it sounds like it might be a while before we get some midterm targets. And I think a lot of investors are just trying to kind of get their hands around defining a reasonable midterm earnings number for Flowserve.
Sure. No, I understand that and I get it. And we do think we want to talk about what the potential of Flowserve is in the long run. If you go back to where we are in the transformation, the assessment got completed at the end of Q3 or Q1. We've now formed the team.
The team is sequencing. We've got things in the pipeline. We want to get a couple of wins and make sure that we've got something that we commit to. And the last thing I want to be doing is throwing out this large prize number and then having to talk about that when we haven't really got the process or the program in place. And so look, we're moving very quickly with this.
And I would say, we do expect to be able to talk about what we think the future of Flowserve is reasonably soon.
Got it. I mean, just big picture, if I look back over the last decade, say, the margins, the op margin has peaked out at around 15%, 16%. I mean, directionally, do you think for now that's a good target? Or do you think just given all the restructuring you've done already and what you have planned that it's reasonable to assume a base case that's at least a little bit higher than that?
Yes. And I'd just say, again, not ready to go fully into this, but we're going to be incredibly ambitious on what we're trying to do here. And we've got a team that's focused and they're energized about doing things that are would be top quartile in the space and exceeding margins that have ever been done closer. Got it. Got it.
But we got to give a little more time before we're ready to commit and show what how that program leads to what the future looks like.
Got it. Maybe just finally for me, I just wanted to clarify a little bit about the end market perspective, especially in oil and gas. I know you have very little upstream, so perhaps limited direct impact of higher oil. But as oil has moved up here, can you talk about kind of connecting the dots on what some of the secondary or tertiary impacts of the higher oil has actually been on the business?
Yes. I think, Joe, obviously oil price drives a lot of things in energy. And so stability above $60 and touching $70 now is definitely a positive to our industry and certainly our business. And what it does, it just gives operators confidence in their ability to start to spend money on large projects. What I would say is, and you said it and it's really important is, our exposure to the upstream side of oil and gas is relatively small.
And probably worse is that our exposure to upstream land is really around FCD and we don't have a giant pump offering in oil and gas upstream land. And so there's things that we're looking at in our product portfolio to make sure that we're driving products into the markets that we see are attractive and growing. But overall, dollars 70 oil is doing a lot of good things and we're seeing smaller projects internationally start to move forward where we do participate. And for us certainly on the pump side and the valve side, what we like are critical service type projects, FPSOs are good, production platforms and big kind of production systems that have harsh environments is when customers come to us for both pumps and valves. And so any of that, that comes through the system is positive and the new price decking kind of stability here is helpful.
All right. Thank you for that color. Thank you.
Thank you. And thank you, ladies and gentlemen. We have reached our allotted time for today's call and will now conclude. Thank you for participating. You may now disconnect.