Flowserve Corporation (NYSE:FLS) Q4 2023 Earnings Call Transcript

Flowserve Corporation (NYSE:FLS) Q4 2023 Earnings Call Transcript February 21, 2024

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Operator: Good day and welcome to the Fourth Quarter 2023 Flowserve Corporation Earnings Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to J Roueche, Vice President, Investor Relations and Treasurer. Please go ahead.

John Roueche: Thank you, Katie, and good morning, everybody. We appreciate you joining our call today to discuss Flowserve’s fourth quarter and full year 2023 financial results. On the call with me today are Scott Rowe, Flowserve’s President and Chief Executive Officer; and Amy Schwetz, Senior Vice President and Chief Financial Officer. Following our prepared comments, we will open the call for questions. As a reminder, this event is being webcast and an audio replay will be available. Please 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 February 21, 2024, and they involve risks and uncertainties, many of which are beyond the company’s control.

We encourage you to 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 accessible on our website in the Investors section. I would now like to turn the call over to Scott Rowe, Flowserve’s President and Chief Executive Officer, for his prepared comments.

Scott Rowe: Thanks, Jen, and good morning, everyone. Flowserve’s fourth quarter performance marked a strong finish to a very solid year of improved execution and consistent progress. Our financial and operating performance throughout 2023 supported raising our full year revenue and adjusted EPS guidance 3 different times as we significantly exceeded our original expectations. For the full year, we achieved year-over-year revenue growth of nearly 20%, driven by enhanced backlog conversion and operational improvement while delivering higher adjusted gross and operating margins. As a result, our adjusted earnings per share increased by over 90%, and our operating cash flow improved by over $360 million compared to 2022. Bookings exceeded $4.25 billion for just the second time since 2016, which supported our strong year-end backlog of $2.7 billion.

Most importantly, Flowserve entered 2024 well positioned to drive continued momentum and success, and we are well on our way towards achieving our 2027 financial targets that were communicated last September. I want to sincerely thank all of our associates around the world for their efforts and dedication throughout the year. Our commitment to serving our customers and their passion for our business are critical to driving exceptional financial results. I’m very pleased with our results in the fourth quarter, including our adjusted earnings per share of $0.68, which brought our full year adjusted EPS to $2.10. We are seeing the impact of our improved operating model higher backlog conversion and significantly better financial performance.

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Q&A Session

These improvements drove fourth quarter sales of nearly $1.2 billion and expanded our sequential adjusted operating margins to 10.5%. We also delivered $195 million of operating cash flow during the quarter, which was driven primarily by our earnings and strong working capital performance. This was a clear highlight for us as we are beginning to deliver improvements in our inventory management as our supply chain continues to normalize and lead times shorten. Our markets remain supportive as we delivered over $1 billion in bookings for the eighth consecutive quarter. While our full year 2023 book-to-bill was just below 1.0x, our backlog remains at a very healthy $2.7 billion as we entered 2024. Let me now provide some additional color on our fourth quarter bookings.

General market activity remains high, and we generated bookings of $1.04 billion in the quarter. We achieved this level due to the success of our 3D growth strategy, coupled with continued high levels of aftermarket and MRO activity that we captured around the world despite the lack of a major project award. We did obtain a significant number of smaller awards in the $5 million to $10 million range which together totaled roughly $100 million across all industries and regions. Our largest project award was only $9 million in the fourth quarter. We remain disciplined on our project pricing approach and margin expectations. While this strategy may result in some lost incremental awards, we are confident that we will ultimately create more value with this selective bidding approach.

Our 3D bookings represented roughly 30% of our total awards during the quarter, where we saw particular strength with LNG, nuclear and water awards. While some of the larger projects we previously expected to be awarded during the fourth quarter were delayed, they remain viable and healthy opportunities for Flowserve in 2024. For full year 2023, our bookings were nearly $4.3 billion. Turning to our aftermarket business. Most of our customers’ facilities continue to operate with high utilization rates. While their focus remains on reliability, efficiency and emissions reductions, we are positioned well to capture the aftermarket and MRO business associated with this type of work. For the ninth consecutive quarter, we generated over $500 million in aftermarket bookings.

For the full year, our aftermarket bookings were nearly $2.3 billion, which were up 5% year-over-year. More importantly, we see the elevated demand for our higher-margin quicker turn aftermarket offerings continuing into 2024. Our overall market outlook for 2024 is very encouraging given the project opportunities and aftermarket trends we are seeing today. We believe the themes of energy security and decarbonization will continue to drive global spending for years to come. At year-end, our total project funnel has increased 13% versus prior year enabling us to remain disciplined and selective in the new project work we pursue. Our oil and gas funnel is up 25% year-over-year, driven primarily by mid and downstream activity in the Middle East, where we’re we are well positioned to capitalize on the significant investment in the region.

Furthermore, our energy transition project funnel also increased nearly 25% year-over-year driven by decarbonization activities in the pursuit of clean energy. We believe we can secure enhanced project bookings in 2024, given the visibility that we have in our forward funnel. Beyond projects, we anticipate our aftermarket and MRO business to remain at elevated levels and support our growth into 2024 and beyond. We continue to see healthy activity levels despite some of the softening consumer trends and economic uncertainty that are highly publicized. Additionally, we are seeing signs of stability in areas that were depressed in 2023 like European chemicals. Our global install base is incredibly large and we have further opportunity to improve our aftermarket capture rates as we go forward.

Overall, we believe that our global network of quick response centers combined with our commitment to serve our customers with speed and high levels of service will allow us to grow our aftermarket franchise further in 2024. I will now turn the call over to Amy to address our fourth quarter and full year financial results in greater detail.

Amy Schwetz: Thank you, Scott, and good morning, everyone. Let me also start by saying how pleased I am with our fourth quarter results, which demonstrated continued operational momentum, disciplined cost management and strong cash generation. For the fourth quarter, we achieved our best quarterly sales level since 2015, an adjusted operating margin of 10.5%, our highest quarter of the year and $0.68 of adjusted earnings per share. Our operating cash flow was also strong at $195 million in the quarter, representing a year-over-year improvement of $125 million. These results continued our recent trend of sequential quarterly improvement across many areas, which led to our outstanding full year 2023 results. Starting with other details in the quarter.

Our reported earnings per share were $0.47, which included $0.21 of net adjusted expenses, primarily below the line FX impacts and realignment charges. Improved operating performance drove a 12% increase in revenues over prior year, comprised of FPDs and FCD’s growth of 13% and 11%, respectively. We also generated strong top line growth in both original equipment and aftermarket, with revenue increases of 15% and 9%, respectively. Many of our regions contributed to the double-digit sales growth as well, with notable year-over-year improvement in the Middle East and Africa, North America and Europe, of 27%, 14% and 13% respectively. Shifting to margins. We generated adjusted gross margins of 29.8% during the quarter, a 100 basis point increase compared to the prior year’s fourth quarter despite higher performance-based compensation expense and the modest mix shift to original equipment.

The margin improvement was driven by increased sales leverage, benefits from our new operating model and continued traction with operational excellence initiatives and an improving supply chain environment. At a segment level, we are particularly pleased to see FCD realize its highest quarterly adjusted gross margins since 2019. At 32.2%, representing a 310 basis point year-over-year improvement. On a reported basis, fourth quarter consolidated gross margins increased 70 basis points to 29.1%. Despite the net increase in realignment and asset write-downs of $4.1 million, versus prior year. Fourth quarter adjusted SG&A increased $39 million to $230 million compared to last year. The increase was primarily due to $13 million in higher year-over-year performance-based incentive compensation and an increase in bad debt of $6 million as well as some benefits in 2022 that did not recur this year, such as the $9 million legal settlement and a small gain on an asset sale of $4 million.

Despite these somewhat discrete items, adjusted SG&A as a percent of sales was 19.7%, driven by solid operating leverage during the quarter. On a reported basis, fourth quarter SG&A increased year-over-year by $41 million to $235 million. In addition to the items just mentioned, our reported amount also includes a net $2 million increase in adjusted items, primarily from realignment expenses. Adjusted operating margin in the quarter was 10.5%, just 30 basis points lower compared to prior year. While our adjusted gross margins this quarter were essentially equivalent to those of the 2023 third quarter, I am very pleased that the sequential adjusted operating margins expanded by 180 basis points for a nearly 40% sequential incremental. On a reported basis, fourth quarter operating margins decreased 70 basis points year-over-year to 9.4%.

Due to higher performance-based incentive compensation, the onetime discrete SG&A items previously discussed and a $6 million increase in adjusted items compared to the prior year, again primarily related to the realignment actions. Our fourth quarter adjusted tax rate of 7.8% was notably lower than expected, primarily due to the release of valuation allowance on certain net foreign deferred tax assets. Our reported rate of 5.6% reflects the items just mentioned as well as the tax impact associated with realignment charges, which we excluded from our adjusted results. Turning to our full year results. We delivered adjusted earnings per share of $2.10, a 91% increase year-over-year. The performance exceeded our latest revised guidance range from October of $1.95 to $2.05 and with nearly 30% above the midpoint of our initial 2023 target range we provided this time a year ago.

Our full year 2023 revenues were over $4.3 billion, up nearly 20% compared to the prior year as our backlog conversion cadence significantly improved with our operational performance. On this sales level, we generated adjusted gross margins of 30.1% for the year, modestly exceeding our prior expectations. Importantly, we remain confident in our ability to expand margins further by accelerating our operational excellence initiatives and ongoing product management of our portfolio. Adjusted SG&A as a percentage of sales was 20.9% for the year, representing our lowest level since 2015. This performance was driven by our focus on cost containment, including the benefits from our recent cost-out program and organizational redesign as well as increasing top line leverage.

While we are pleased with the progress we have made to date, we know that the work on this front is never done, and we will remain focused on driving even better results. Our full year adjusted operating margin was 9.5%, a meaningful increase of 330 basis points over the prior year. Both FCD and FPD delivered solid 2023 performance, keeping pace with significant increases in adjusted segment operating margin of roughly 320 and 330 basis points, respectively, to 14% and 12.4%. Looking ahead, we are well positioned towards our longer-term 2027 consolidated adjusted operating margin target of 14% to 16% that we shared at our Analyst Day in September. Our adjusted tax rate of 15.1% for the full year finished below our previous expectations, primarily driven by the release of valuation allowances on specific foreign net deferred tax assets as we believe those benefits will now be realized based on our improving financial results and help mitigate future cash taxes.

Turning now to cash flow. We delivered outstanding full year operating cash flow of $326 million, which represented a nearly $366 million year-over-year improvement. In addition to our higher earnings, I’m also very pleased that we improved cash from working capital by nearly $240 million, and our cash conversion cycle decreased by roughly 10 days compared to 2022. During the fourth quarter, we generated operating cash flow of $195 million, an increase of $125 million compared to the prior year. The improvement can largely be attributed to our strong working capital performance. Accounts receivable was a modest source of cash this quarter despite our increased revenues, but represented a $77 million improvement compared to the prior year.

Collections results have been robust all year. But notably are evidenced by the nearly 7-day reduction in our day sales outstanding year-over-year in the fourth quarter. Inventory also contributed to working capital progress as we’ve reduced the cash used by over $50 million for both the fourth quarter and the full year compared to the respective periods of 2022. As a percent of sales, we improved our year-end primary working capital by approximately 450 basis points to 27.9% and improved sequentially by 260 basis points as well. We made great strides towards reducing our working capital and investment to our 25% to 27% long-term target and it will remain a major focus area for us going forward. Capital expenditures were $20 million during the quarter, bringing this year’s free cash flow to $175 million.

This year-over-year improvement exceeds $100 million and resulted in a free cash flow to adjusted net income conversion of 194%. Other significant uses of cash in the fourth quarter included $26 million for dividends and a $10 million term loan reduction. Turning to our 2024 outlook. We expect to continue building on our operating momentum to deliver full year revenue growth of 4% to 6%, with adjusted earnings per share between $2.40 to $2.60, both consistent with the qualitative guidance we provided at our September Analyst Day. At the midpoint, our 2024 adjusted earnings guidance represents a roughly 20% increase over last year. As Scott mentioned, our markets continue to remain active, and we expect to generate a full year book-to-bill ratio over 1x, building backlog to spur multiyear revenue growth.

We also expect net interest expense in the range of $60 million to $65 million and an adjusted tax rate of approximately 20%. Our adjusted targets exclude expected realignment expenses of approximately $30 million as well as other potential items that may occur during the year, such as below-the-line foreign currency effects and the impact of other discrete items. Including the potential realignment spending, we expect our reported EPS to be in the range of $2.25 to $2.45 per share. Similar to last year, we will work to minimize top line reduction as we move from the sequentially strong last quarter of the year to the first quarter. That said, we would anticipate our general trend of seasonality and earnings will continue in 2024, with the first quarter being our lowest earnings quarter of the year and the fourth quarter being the strongest.

We intend to further drive value creation through our capital allocation approach. As we weigh opportunities to allocate capital, we are guided by our enduring framework to deploy excess cash to the highest long-term return while remaining impartial as to how value is created. Our Board has authorized a 5% increase to our dividend to $0.21 per share. Additionally, the Board also replenished our authorized share repurchase capacity to $300 million. As we indicated at the Analyst Day, we view share repurchases to offset equity compensation as a commitment and with the increased capacity of the new plan, we also can act opportunistically. That said, we believe there are ample opportunities to invest in the business, both through internal programs and inorganic growth.

We expect capital expenditures between $75 million and $85 million this year, and we are well positioned to pursue M&A opportunities to further expand our portfolio of flow control offerings to better support and accelerate our 3D strategy. We are most interested in targets that provide the opportunity to leverage our scale and that can be effectively integrated with our broader business. Financial discipline and economic returns are table stakes. So the returns on any acquisition would be in excess of our average cost of capital as well as the margin and cash EPS accretive. Through it all, our capital allocation approach is designed to maintain our investment-grade rating, and we intend to reduce our term loan by $60 million this year. I am proud of the strong foundation we established during 2023 and feel confident that we can drive continued margin and earnings per share growth, while deploying capital to deliver long-term shareholder value as we progress towards our longer-term targets.

I fully expect 2024 to be a great start on that journey. Let me now return the call to Scott.