Flowserve Corporation (FLS) Q4 2018 Earnings Report, Transcript and Summary

Welcome to the Flowserve 2018 Fourth Quarter 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. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Jay Roueche, Vice President of Investor Relations and Treasurer. You may begin.

Thanks, Paulette, and good morning, everyone. We appreciate you participating in our call today to discuss Flowserve's fourth quarter and full-year 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 will open the call for your questions. 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 February 21, 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 and the reconciliation of our non-GAAP metrics to our reported results both of which are included in our press release and earnings presentation and are available on our website at flowserve.com in the Investor Relations section. I would now like to turn the call over to Scott Rowe, Flowserve's President and Chief Executive Officer, for his prepared comments.

Thanks, Jay, and good morning everyone. Thank you for joining today's earnings call. Flowserve finished 2018 with a strong fourth quarter. We continued to build on the operating improvements from prior quarters, delivered enhanced earnings, and grew the business with our third consecutive bookings quarter over $1 billion. I’m pleased with the progress we are making in our Flowserve 2.0 transformation journey and the increased engagement of our associates. We have better visibility, a defined improvement plan called Flowserve 2.0, operational momentum, and we are beginning to execute at a higher level companywide. Let me begin today by providing some comments on our fourth quarter and full-year results, our operations, and our end markets. For the fourth quarter, we delivered adjusted EPS of $0.58, which represents growth of over 16% both on year-over-year and sequential basis. For the full year, Flowserve delivered adjusted EPS of $1.75, which is at the high end of our revised guidance, representing approximately 29% growth compared to full-year 2017. We successfully avoided the operational issues that were encountered in 2017, and we improved the performance in each of our segments throughout the year. One area of intense focus in 2018 was margin expansion. For the quarter, we increased adjusted gross and operating income margin by 300 and 170 basis points, respectively. For the full year, we delivered a 90-basis-point improvement in adjusted gross margins and 100 basis points in adjusted operating margin. Our progress with margin expansion is driven primarily by our actions within the transformation program, and specifically from the commercial and operations work streams. Turning now to our markets and bookings. The overall conditions in our end markets remained generally stable in the fourth quarter despite the volatility in commodity prices. While the quarter did not include any individual large projects, we did book a number of $5 million to $15 million awards across each of our end markets, and again saw growth in our aftermarket bookings. Bookings of $1.05 billion were the highest level we’ve delivered since 2015. Year-over-year, it represents an increase of 6%, including headwinds from currency and divestitures of approximately 4%. For full-year 2018, bookings were over $4 billion and were up 5.7% compared to 2017. The general health of our markets, coupled with the growth initiatives we have implemented thus far as part of our transformation are key drivers of these results. During the quarter, we delivered strong results in our aftermarket franchise with the highest level of bookings since 2014, representing growth of nearly 15% year-over-year or over 18% on a constant currency basis. This quarterly performance helped drive full-year aftermarket bookings to a year-over-year increase exceeding 10%. The commercial intensity program embedded within Flowserve 2.0 has our aftermarket organization focused on growth and further capturing the opportunity inherent in our large global installed base. Additionally, our customers appear more focused on facility maintenance, facility efficiency, and meeting regulatory requirements than we have seen in the past few years, leading to additional opportunities for growth. Turning now to our booking by end markets, and starting with our largest market oil and gas. Bookings in the fourth quarter increased 14% year-over-year, driven by EPD where we continue to capture downstream investment, including highly engineered products critical to refining modifications for clean fuel production. Additionally, one of our strike zone initiatives that we have discussed previously is our focus on North American pipeline projects. In 2018, this commercial focus drove several wins across segments including roughly $20 million in the fourth quarter, and we have good line of sight into a number of additional opportunities in the first half of 2019. For the full year, oil and gas bookings were up 8%. Based on our customer discussions and the status of their pre-FEED and FEED activities, we expect increased investment in 2019 for both upstream and downstream oil and gas despite recent oil price volatility. In chemicals, our quarterly bookings increased approximately 3% year-over-year on 18% growth in FCD and a 3% increase in IPD which more than offset the decline in EPD. On a full-year basis, we delivered growth of 6%, with all segments contributing. We remain confident in the North American ethylene project pipeline and we also expect increasing investment in Asia and the Middle East as oil majors and national oil companies increasingly pursue integration of the petrochemical value chain. The power market remains our most challenged industry, where fourth quarter bookings declined 17% year-over-year, although EPD was essentially flat. For the full year, power declined about 11%, with only IPD delivering growth. We continue to have muted expectations in the power markets near-term due to industry wide headwinds. Fossil opportunities in Asia remain challenged and competitive. Nuclear build in Asia continues, while Western nuclear new builds are limited and most of the opportunities lie in extending the life of existing facilities, upgrades, and maintenance. However concentrated solar power continues to be a niche opportunity for Flowserve in a growing renewables market where we have a differentiated technical offering. General industry bookings increased 13% year-over-year this quarter, primarily driven by FCD’s growth of over 40% and strong distribution activity. EPD also contributed nearly 11% growth. This end market includes the mining and pulp and paper industries, which contributed quarterly bookings growth of 50% and 30% respectively, although both markets represent less than 5% of our overall mix. For 2018, general industry grew over 12% year-over-year. Lastly, the water industry, which represents the smallest category we breakout on a standalone basis, declined 19% year-over-year in the fourth quarter representing 3% of our total bookings. For all of 2018 water increased approximately 3% compared to 2017 due to strong performance in EPD with several larger flood control awards. Looking at bookings by geography, we delivered solid quarterly and full-year growth in most regions. Compared to the 2017 fourth quarter, North America was up 11% while the Middle East and Africa increased 16%, and Asia Pacific was up 21%. Europe decreased 6% while Latin America decreased 15% off a very low base. For the full year, North America, Europe, and the Middle East and Africa increased mid-to-upper single digits while Asia-Pacific and Latin America each contributed 3% growth. Let’s now turn to our performance by segment. I will start with IPD where we continue to make good progress. The segment delivered reported and adjusted operating margins of 9.6% and 10.2%, while making significant strides on the operational turnaround in the reduction of past due backlog. We are encouraged with this step up in performance, but recognize that much work remains to drive a consistent operational excellence, on time delivery and customer experience that is needed and expected. We believe that continuing to improve our performance will get us closer to achieving the desired mid teens operating margins from the industrial product portfolio. While the quarter results were buoyed somewhat by fourth quarter seasonality. We are encouraged with IPD’s progress and continue to believe we are on the right path. EPD also had a solid fourth quarter bookings in that segment increased 12% year-over-year including 20% aftermarket growth. Additionally, we made meaningful progress on past due backlog and improved adjusted gross and operating margins by 200 and 250 basis points, respectively year-over-year. We are fully focused on leveraging the full capability of our engineered pump portfolio to better serve our customers and ambitiously grow our business. FCD continues to perform a high level, the segment has consistently delivered strong operating performance, including this quarter's adjusted gross margin expansion of the 100 basis points to 36.3% even as revenue declined 5% on a challenging compare. Throughout 2018, we improved our ability to deliver predictable financial results and limited much of the quarterly operating income variability that we have seen in the past. We have an extensive valve portfolio and we are well-positioned to take advantage of the expected increase in project activity during 2019. I will now turn it over to Lee to discuss our financial results in greater detail, and then I will return for closing remarks before we open the call to Q&A. Lee.

Thanks, Scott and good morning everyone. Looking through our financials as Scott highlighted, we delivered adjusted earnings per share of $0.58 in the fourth quarter and $75 for the full-year in-line with our revised guidance we provided as part of third quarter results. On a reported basis, fourth quarter EPS was 48% which included realignment and transformation expense of $0.13, a penny of below the line currency impact and $0.04 of benefit related to U.S. Tax Reform. Fourth quarter sales of $987 million decreased 4.6% versus prior year, which included approximately 4% of headwind from currency and divested assets, sequentially fourth quarter revenues increased 3.6%. As we discussed previously, our traditional seasonality marked by a strong fourth quarter top-line was muted somewhat in 2018, due to the new accounting standard implemented at beginning of the year. For the full-year revenues were $3.8 billion an increase of 4.7% compared to 2017, with all segments contribute to year-over-year top-line growth. Turning to our margins, fourth quarter adjusted gross margin increased 300 basis points versus the prior year to 33.7%, which is the highest quarterly level since 2015. IPD’s 830 basis points year-over-year improvement represented over half of the increase. Additionally, as our transformation initiatives are taking hold we continue to focus on project execution, disciplined cost control and improve the quality of our backlog. On a reported basis the 300 basis point gross margin increase was driven by essentially same factors as realignment expenses were roughly $11 million for both 2018 and 2017 fourth quarter. For the full-year, adjusted gross margin improved 90 basis points year-over-year to 32.3%. Fourth quarter adjusted SG&A increased a modest $3 million due to elevated corporate for discreet litigation accruals and expenses, sales commissions and medical claims. On a reported basis, fourth quarter SG&A was further elevated due to transformation expense, which we expect to see decline in future periods. For the full-year however, adjusted SG&A as a percentage of sales declined 20 basis points to 22.8%. With strong gross margin improvement and an ongoing focus on cost control, Flowserve’s fourth quarter adjusted operating margin increased 170 basis points year-over-year to 11.9%. IPD’s significant 950 basis point improvement coupled with EPD’s 250 basis point increase more than offset FPD decline in higher corporate cost. On a reported basis, operating margin increased 80 basis points where improved operating performance more than offsetting eight million increase in adjusted items, primarily related to transmission cost. For the full-year 2018, adjusted operating margin improved 100 basis points to 9.8%. Our reported effective tax rate 18.1% benefit from the true up associated with last year U.S Tax Reform accrual. On an adjusted basis, the effective tax rate for the quarter of 26.1%. For the full-year, our adjusted tax rate of 27.1% was in-line with our guidance of 27% to 28%. Turning to cash. Our fourth quarter operating cash flows were again seasonally strong at $164 million, primarily due primarily due to working capital improvement and building upon the progress of the preceding two quarters. Our free cash flow in the quarter was $130 million, or roughly $1 per share revenue representing a conversion rate, well above 100% of our reported and adjusted net income. Capital expenditures for the quarter in year were $34 million and $84 million, respectively. We continue to pursue IT investment in the quarter that support and enable our Flowserve 2.0 agenda, we continue to invest in various growth and restructuring initiatives. For the year, we returned approximately $100 million to shareholders through dividend and repaid $60 million of term debt. With our strong fourth quarter cash flow, we ended the year with solid cash balance of $620 million, an increase of $90 million from the end of 2018 third quarter. As I mentioned, we delivered modest primary working capital improvements during the fourth quarter with working capital percentage of sales of 27% representing both year-over-year and sequential improvement of 90 and 190 basis points, respectively. As I shared with you at our analyst day in December, free cash flow conversion and growth is a significant opportunity for Flowserve. We certainly acknowledge much work remains to achieve the consistent level of cash flow conversion that we believe Flowserve can and should ultimately deliver. A number of our Flowserve 2.0 transformation initiatives are focused on obtaining the systems and process improvement tools directed at all aspects of both the order to cash and sales and operational planning process. We expect additional progress in 2019 and beyond, as we continue to target our longer-term aspiration of 100% plus free cash flow conversion. Turning to our 2019 outlook. We are targeting full-year adjusted EPS of $1.95 to $2.50 a share on expected revenue increase of 4% to 6%, including approximately 2% of expected headwind due to currency and divested businesses. This level of performance would very much keep us on track with our longer term 2022 targets we laid out in December. The adjusted EPS target range exclude expected realignment and transformation expense of approximately $55 million as well as below the line foreign currency effect and the impact of central other discrete items which may occur during the year such as acquisitions, divestitures, tax reform laws, et cetera. Our outlook assumes that volume, price and productivity will offset the potential incremental headwinds in 2019 due to inflation, FX, merit and the planned increase in research and development in IT investments. Both the reported and adjusted EPS target range assumes current FX rates and commodity prices. Our expectations are based on 2018 year-end backlog, anticipated booking level and the continuation of our current market conditions. Net interest expense is expected in the range of $55 million to $57 million with the tax rate of 26% to 28%. Additionally, we expect traditional back half weighted seasonality similar to the 2018 quarterly phasing of cash flow and earnings. From a 2019 cash uses perspective, we expect to return approximately $100 million through dividends to our shareholders. Capital expenditures are expected in the $90 million to $100 million range, we also expect full-year, debt repayment of approximately $60 million and to contribute approximately $20 million to our global pension plan, mainly recover ongoing service cost as U.S plan remains largely fully funded. Now, let me turn it back to Scott for his closing remarks.

Thanks, Lee. As we wrap-up, I would like to spend a few minutes on our 2019 outlook and the progress of our transformation efforts. Many of you joined us at our Analyst Day in December, when we laid our transformational initiatives and longer-term expectations in greater detail. For those who may have missed it, the presentation and audio from the event are still available in the Investor Relations section of our website. To summarize the key takeaway, we are executing our multiyear transformation with a sense of urgency. We are changing the culture, improving employee engagement, simplifying our process and creating an operating model that will weather different market conditions. Our long-term focus at Flowserve is to grow the business, expand our margins, improve return on invested capital and enhance the organizational health of the Company. As our fourth quarter results demonstrate our actions are beginning to bear fruit. While we are improving we still have a long way to go, but we are committed to implementing lasting change to create sustainable long-term value. As we previously announced, beginning January 1 of this year, we combine our IPD and EPD segment into one closure comp division. This new operating and reporting segment further simplifies and standardizes our operating model. While we do expect to drive modest cost savings as a result the real catalyst with the combination is to drive productivity and value for our customers. The initial response from customers has been very positive. We fully expect to see this new organization will greatly enhance our customers experience with Flowserve. Turning our expectations for 2019. We remain confident in the stability and continued growth of our end markets. Our growth oriented transformation initiatives provide the opportunity to outperform the underlying market while our cost in operational initiatives can further drive margins. We believe that we have the opportunity to grow adjusted EPS nearly 20%, again year-over-year when we use the midpoint of our guidance. The transformation activities that are underway give us confidence that we can produce a sizable improvement. With the traction we gained in 2018 on our operational improvements, we are confident that we can deliver on our 2019 targets. While we have delivered some additional financial from the transformational program, we are still in the early days. With each quarter, we expect to gain momentum, which will put us on the path to reach the longer-term targets we laid out in December. I’m very pleased with the progress we have made including the ongoing engagement and commitment of our associates. We are taking the right actions to build the performance and accountability driven culture to create value for our customers and our shareholders alike. Operator, we have concluded our prepared comments and we would like to open the call to any questions.

Thank you. [Operator Instructions] The first question comes from Jeff Hammond from KeyBanc. Please go ahead.

Hey good morning guys. Just maybe you could talk about the disparity between aftermarket growth and OE and how you think those trends as you look at visibility shape up as you move through ‘19.

Sure. Let me start with aftermarket and then I will hit the OE. We are really pleased with the growth and what is happening in the aftermarket program. As I talked in December at the Analyst Day, we launched what we’re calling commercial intensity. And essentially what that is -- and we went through it again in December. But what that is, it is really looking at what do we have from an installed base perspective, where our QRCs are and really maximizing the opportunity at each of those locations. And we launched this in the summer of last year and we are really seeing very positive results. We have now done pilots in each of the major geographies we are pretty much in place and live across all of North America, most of Europe, and we have just started in Asia Pacific. And so, this commercial intensity program is really helping us to grow the business. On top of that, we are seeing some macro trends that are helping us in the aftermarket side as well. And what that is, is just after several years of delayed spending on maintenance and the focus on reliability, we are seeing a renewed effort in renewed spending and maintaining equipment and making sure that they are using our products and our service. So, the aftermarket growth has been really positive and we definitely expect that to continue as we go forward. On the OE side, it really hasn't been bad, it’s just lower than what we are getting with the aftermarket side, and what I would says is as we transition into 2019, our OE visibility, particularly on the project side is significantly higher than what we had at the beginning of last year. So our project pipeline is reasonably full. What we are seeing from the big customers that report externally is that their capital is at or above what they are stating for - at or above for 2019 over what it was in 2018, and then when you look at the EPCs, their backlogs are higher than they were over last year as well. And so, our project pipeline remains really healthy, and we feel good about the MRO and the aftermarket side. So, we are encouraged about our growth activities and prospects in 2019.

Okay, great. And then it sounds like you are making progress on past due backlog, can you just give us a sense of where you're at in kind of getting that fully caught up and kind of fully behind you from here. Thanks.

Yes. We are making progress on past due backlog and in the fourth quarter we made significant progress, and so I’m not going to say we are completely out of the woods here, because we are not. We would have liked to make a little bit more progress in the fourth quarter than we did, but what I would say is on the IPD and the EPD side, we took a big chunk of capacity past due down. We hired a new Vice President of Operations in July, we formed a new manufacturing organization in 2018, and all of that reorganization, the talent improvement, and the focus is absolutely driving the right results. As you know and most people listening to the call, the past due backlog was really a headwind and hurting us in lots of different ways. It’s hurting our customer relations, it’s hurting us on revenue. It was incurring more costs and hurting on the gross margin, and then it hurt us on the working capital with built-up inventory and delayed receivable collection. And so getting this behind us is a huge focus. And what I would say is, we are in a substantially better place than we were in 2018, and while we are not quite to the level that we expect what we want, we are actually really close to where we need to be. And so as we go forward, really, we are not going to let up on the focus of past due backlog and on-time delivery, but we are really going to start focusing on lead times for our products and making sure that we can be extremely competitive getting our products in front of customers at the time they need it.

Okay, that’s good to hear. Thanks Scott.

Thank you.

Our next question comes from John Walsh from Credit Suisse. Please go ahead.

Hi, good morning. So, I guess could you talk a little bit about what you are seeing out there in terms of pricing and maybe provide some context around material costs. I know, obviously you talked about productivity in there as well and there is general inflation, but maybe just trying to isolate pricing by itself and kind of the price/material cost equation.

Yes, sure. Let me just start, I will take general comments, and I will get real specific on the pricing side. Generally speaking, and as you saw throughout 2018, we were able to grow our margin because we were on the right side of the price/cost curve. And so, as I discussed before, we did several price increases at the beginning of 2018, which offsets the inflation in tariffs and other headwinds that we had in the global environment. And so, we feel really good that we have got the right focus and the attention on that. Now, as we switch to pricing for 2019, we announced our price increase actually in December of last year, and it is fully in place today across all of our products. The big question now is just how sticky is that and how much can we get, but what I would say is, at Flowserve, we are in a privileged position of having great brand recognition and being on ADLs [ph] around the world. We have got to translate that into better pricing. And so we are going to be pretty aggressive on the pricing side, again as evidenced that we have already announced our price increase and we are locked in. And then the other thing we have done is in the Flowserve 2.0 transformation office, one of the work streams is focused and is all about pricing. And so when I tell you about general price increases, that's great, but it's really there to stay current with inflation and what is going on. On the strategic side of pricing we are getting a lot more analytical and sophisticated about making sure that our price distribution internally is where it needs to be and that we are capitalizing on all the opportunities that we have. And so you know that work is now starting to come through and we are seeing positive results of the analytical aspect of pricing within the transformation. But I would just say for 2019 we feel really good, we are going to be on the right side of the price cost equation. What I would say is you know, it’s still a volatile environment in terms of tariffs and trade and things like that and so it’s obviously something we are staying very current on and we are staying abreast of. But right now given everything we know, we are in a good position with our newly announced pricing and we will move forward. And then just the last thing I would just say, just like when we think about our competitors, it’s still not an environment that I really like and we are seeing other competitors not necessarily follow suit. And so when we see that we are prepared to walk away from some of the business that doesn't make sense for us or doesn't give the margins that we want, and I think that's a little bit of a change from where we were certainly in 2017 or maybe 2018. But I also believe that the marketplace in general is moving in the right direction on pricing and I think we are moving into a good spot for 2019.

Great, that's a good color, thank you. And then maybe just a follow on here, as we think about the incremental margin that you're expecting in 2019. I guess at the segment level you have been executing in like a low 40s the last two years, is that still the right zip code to think about for 2019?

Well we don’t give guidance on the segment level, and so I think what you can look at is the general 2019 guidance on the revenue side and EPS, it implies that we continuing to expand margins through 2019. And so with the transformational activities around supply chain and cost takeout in the pricing that we discussed, we fully expect to increase growth and operational margin throughout the year.

Great. Thank you.

Our next question comes from Deane Dray from RBC. Please go ahead.

Thank you. Good morning, everyone. Maybe just a follow-up on that price cost discussion. Scott, when you talk about having put price increases in December, did you think the fourth quarter benefited at all from some pull-in form the first quarter? We have heard a number of companies seeing that, people trying to avoid those price increases. Any sense that that happened this quarter?

Yes, Deane it’s a great question and its actually what we expected and it didn’t happen. So we were fully expecting to see a little bit of an uplift particularly on the valve side on the FCO side with some pull in business and it didn’t materialize. Now we gave them more than the December window and so we are getting some benefit of that in January, but certainly have not seen an outsized uplift because of the price increases going in place.

It's really interesting. So how precisely can you gauge whether an aftermarket order is coming in? I guess, would it be because it's coming in at the old price or is there any way that you can be more precise in knowing and order's coming in like organically into the fourth quarter as opposed to trying to avoid the price increase?

Yes. This is really a good question. One of the reasons we set up the pricing work stream and the transformation was because we didn’t have the analytics and the visibility to really understand this is as well as we wanted. So what I would say at Flowserve is, we are getting a lot better at understanding the nuances on this, where we can really see those with our distributors and the ones that - particularly the ones that stock products right. And so there we have got some history with them and we can see what they have historically done when we announce price increases and that’s both on the valves new and the aftermarket. And we can get a little bit of that with our parts business with your preferred partners. But what I would say is that the visibility isn't as good as what we want and part of that transformation effort is to really get more sophisticated and analytical with our whole pricing.

Got it. That's a really helpful answer. And that just begs the question of how has the first quarter started out in January, if you could?

Yes, so right now I mean we wouldn’t have gone out of the guidance that we did, if we didn’t have a good data point here in January. So I would say normally we would expect a showdown in January on bookings a little bit, but right now out of the gates things look pretty good both on the aftermarket and the OE side. We feel reasonably confident in the first half of the year that we will continue to grow the business. I would say the only concern that I have for 2019 is and I talked about this before, the project business we have good visibility on and we see projects being awarded and our bookings for projects going up throughout the entire 2019. Where the concern could be is on the MRO or the base of the aftermarket business in the second half of 2019. So that's what we are watching really carefully, but right now at least the preliminary signals at the beginning of the year are still positive that the base business or the MRO business is still continuing at a healthy rate.

Good to hear. And just last question for Lee. I hate to put you on the spot, but working capital percent of sales in that 27% range did not improve year-over-year. Scott mentioned that you have got that drag from past few backlog, it's still inflating some of your receivables. But what is the target? And how quickly can you ramp down that percent of working capital for 2019?

So you definitely put me on the spot Deane. And it’s an area that continues to be a frustrating area for all of us. As we have talked about at the Analyst Day and what we talked about in every earnings call, it is a significant focus. We are very focused on working capital and cash flow during the year. One of the things that we are doing is changing our incentives to drive better working capital performance during the year. Historically, a lot of our incentives were more year end focused. So you have this big push at the very end, but during the year you would not have the intensity around it, we expanded our incentive plans include more leaders around working capital. So we are I think pulling all the levers that is required to do it, but as we talked about at the Analyst Day, there are a lot of challenges given our systems and our processes and a lot of the Flowserve 2.0 is about putting plans in place to address those and put systematic fix in place. So we are not going out with a percentage of how much working capital we are taking out, but I will tell you it is - we had internal aspiration and targets that we are going to make major steps in driving reduction both in inventory and receivables.

Thank you.

Our next question comes from Scott Graham from BMO Capital Markets. Please go ahead.

Hi, good morning. I have got a couple of questions around the sales guidance, which organically looks like up 6% to 8%. And I guess, what I'm wondering if there is a reason that you went out with a number that large, and certainly understand the last couple quarters' bookings. But also, if you take a peek at the fourth quarter sales, those probably could have been a little bit better, whether that's a shipment issue or what have you. So just two questions around the revenue guidance is: Number one, what kind of gets you to the high end versus the low end? And number two, there is an assumption in there of significant amount of book-and-ship business, and I'm just hoping you can give us some data points around that assumption.

Sure Scott. It’s a great question and I think where we get confidence is our backlog is up year-over-year and so we had good bookings in Q3, we had good bookings in Q4. A lot of the bookings that came in Q4 were a little bit further in the quarter like book in late November and December rather than the beginning of the quarter. And so we have got pretty visibility for revenue growth in the first half of 2019 and so I feel good about that and kind of the market comments that I just said is, we were tracking some good project work in 2019 and additionally, the health of the MRO business, which is very much a book-and-ship business throughout the year has started off 2019 in a healthy place. In the last data point here is, while we have made significant improvement in past due backlog, there is more work to come and by clearing that and getting to the place that we need to gets our revenue into a place that gets right there within the guidance and so we feel reasonably good about the revenue guidance. The upside, we mean we need to book some projects earlier in the year and then with the new accounting standard, the overtime or percentage of completion accounting we are picking up that revenue earlier than what you would have historically done with units of completion accounting. But I think if we can get some of the - and when I say larger projects, you know I’m thinking kind of $15 million to $30 million one, if we get those secured then is some real nice revenue uplift throughout the year there and would put us on the high side.

And you are working on those projects? Is that on a pre-FEED or FEED basis?

As I have said before, we feel really good about the project pipeline right now. And so a lot of these are into FEED, they are at the EPCs. And quite frankly, a lot of them are out in the tendering and we are bidding on them right now. So we have got a healthy list of projects and again, these aren’t the mega, we are not looking at $100 million big project like we have announced before, but we are seeing a robust list of anything between kind of $15 million and $30 million with a few that are between $30 million and 450 million range and securing fewer those will put us more to the high side of that revenue guidance.

That's great, thank you. And then if I could just ask a second question about our old friend, IPD, which really surprised me, and I suspect others. I'm sure that it wasn't all pushing out past due backlog for the delta in the margin. Could you give us a couple of things that really went right in the business beyond the past due backlog reduction?

Scott it’s a really good point and we delivered the 10% adjusted OI, it was kind of what we had communicated publicly, kind of mid to high single digit. So this is above what we expected. What I would say though is, the IPD team with David Wilson leading the charge here, has just done a really good job throughout the year putting the systemic and the structural things in place to move our margins back into our somewhat acceptable territory. And a lot of that is the past due backlog reduction, we took some hard cost reduction activities throughout the year, but particularly in Q2 and Q3. We also divested the business that quite frankly was not performing well and was in the high cost region and the effort and the cost to turn it around was not worth the time or the effort in the distraction to do that. So I think the combination of your cost reduction clearing the past due, the divestiture in the business and then what I just said and its going to sound probably - it’s not the most sophisticated answer, but it really is blocking and tackling. So we have got some really, really good products within the IPD portfolio and it’s how do you capitalize on those products and make sure we are getting them to our customers and getting the margins that we deserve and how do we deemphasize them work that wasn’t making money and not doing the right things and so moving away from that and really starting to focus on the place that we can create value and make money for Flowserve and for our investors. And I would just say David brings that great perspective and the balanced approach that allowed us to move margins forward throughout the year. Now what I would say is, I do want to caution we are probably not going to have a Q1 that we are going to generate 10% adjusted operating margin, but we are not going to be back to the levels that we had in 2018. So we have made a step change improvement for the year, we do expect to go forward, our target in this business remains a mid-teens type business that would generate the proper return on invested capital in the industrial space. And in order to achieve that, there are still some operational work that has to be done. There is further cost reductions, we have got to move the consolidation to pump platform together and get some other cost take out, we have got to be more disciplined on our pricing in our order execution and then we have got to continue to improve the operational controls at the manufacturing side in the operational locations within the business. But great progress in the fourth quarter and while margins will come down a little bit in Q1, we fully expect to capitalize on this momentum and keep moving the IPD business forward.

Thank you Scott.

Our next question comes from Andrew Obin from Bank of America. Please go ahead.

Hi guys good morning. Just want to clarify if I have heard it correctly that you guys said that you have more confidence in large project orders in 2020 versus MRO sustainability into second half is that correct?

For 2019 yes, we feel really good about the pipeline and the projects and again the large operators have communicated publicly their capital spending and you can see in the UTC’s backlog that those projects are throughout FID and they are starting to move forward. So we are in the middle of transacting and quoting for a number of large projects, we feel pretty good about the health of these projects. Now that can change and things do change, but everything we are seeing today, I would say that the 2019 project portfolio is better than where we are at in 2018 at this time. Just I want to finish on MRO side. What I said on the MRO side is currently fourth quarter and our January data point looked really good. And so what we are seeing is continued MRO spend. The MRO spend can be cut off immediately and so if we have risk what I'm concerned about is a potential slowdown in the MRO business in the back half of 2019. But right now, everything we see and where we were at the end of Q4 and what we have seen at the beginning of this year, all looks good that the MRO spending is relatively healthy and combine that with our internal initiatives then we should to grow the MRO spend as well.

Yes. I guess the reason I asked, because one of your competitors sort of highlighted the fact that they actually expect bookings to accelerate into 2020 and I guess they felt quite a bit better about MRO, but I think there were highlighting sort of pet-chem and LNG into 2020. Can you just talk about how much visibility you have on a longer term basis, because these are very long-windowed cycles and I’m just wondering if you guys could actually see acceleration in bookings on OE work into 2020 if that’s a possibility.

Yes. We are very focused on 2019 here, but I would just say, our lens and window is not as great as it needs or should be. But I will answer the question, again right now what we are seeing and I would say on the oil and gas side primarily refining and the midstream space plus the chemical space, there are a lot of project opportunities that go from 2019, 2020 and into 2021. And what has happened is there has been a significant underinvestment over the last four years and so at some point that catches up, we showed this at in our pressure curves is in the December Analyst Day. And so if you believe the pressure curves and it's kind of the under spending theory and that demand stays somewhat constant or it grows a little bit then you get increased capital into 2020. Now what I would say is I’m not going to go a 100% and commit that 2020 is going to be a great number, but right now the project portfolios look pretty good and things are lining up to continued health in bigger projects and infrastructure spending for 2019 and 2020.

And how are you thinking just a follow-up, because the same competitor highlighted the fact that they sort of need to hire more engineers and field technicians. Imagining of planning of sort of roof capacity to meet the growth, but do you have the people and where do you get them?

Yes. So right now we are communicating a reasonably moderate growth level of 5% to 7%. We have plenty of people, we have got plenty of capacity and that is not a concern for us right now. There are some very niche aspects in our business that have grown at an outsize than others. And so that's an area where we have got to do some selective hiring, but in general this is not a concern for us at Flowserve.

And I will just sneak one more and I apologize. Just in terms of the mix OE and aftermarkets, are you guys being more selective on OE in Q4? Is that part of what happened in Q4?

No, I would say we started being more selective on the OE earnestly at the beginning of last year. And so what I would say is we have been selective. I don’t think it's necessarily a cause for a little bit lower OE. I would say some of that was just timing of orders and some of it could be due to selectivity. So we have raised our margin expectations and we have raised our price when those things happened and we are not going to win some of the awards that potentially could have come our way.

Terrific. I really appreciate your time. Thank you.

Okay. Thank you.

Our next question comes from Brett Linzey from Vertical Research Partners. Please go ahead.

Hi, good morning everyone. Just wanted to come back to the aftermarket, I mean very solid bookings in the quarter. I mean historically those aftermarket bookings tend to ship in the quarter, but you had sales only up modestly. So just trying to understand the disparity there it's been wider than it has been in quite some time. Is it the nature of the work or customers ordering further outs, preorder had a price any color would be helpful?

Yes. So no, again the MRO bookings and the aftermarket bookings in the fourth quarter were fantastic. What I would say is a lot of that came in a little bit later in the quarter and so we didn't get to do the book-and-ship that we wanted. But the backlog is up and we feel very good at converting that. Its typically very short cycle work within like you said it's within a three month window and so I would expect us to convert on the backlog and see nice growth in the aftermarket side of our business.

Okay good. And then maybe just shifting back to free cash flow, specifically working capital inventory and some on the asset side. It sounds like plans are under the way, you guys are making progress there to address some of those issues, but you are guiding for fairly strong sales for the year, which typically requires some working capital build. So I guess in that context do you think that working capital assets can be a source of cash this year given that balance?

I will let Lee to answer this question.

So Brett, what we are modeling right now is we are really driving to improve the velocity of those. At a minimum it would be nice to keep at least somewhat flat, but it could be slightly a burn depending on where the sales end up. So we are focusing on as I said the velocity and the of turnover both AR and inventory and obviously managing our payables correctly. So it will be nice to drive the growth and minimize the cash burn associated with that.

Yes. So really what we are trying to do is, if we can bring down the velocity on those two then it will offset the need of working capital build with the growth of the business. So I would say it’s probably not going to be a source of cash, but this is a huge opportunity for Flowserve, we have got a lot of attention and focus on it. What I would say is, some of the numbers don't necessarily show this, we have actually made tremendous progress in the back half of 2018, and so we fully expect to continue on that progress. And then the other thing I want to highlight and Lee said this earlier, historically at Flowserve we have been very focused on working capital at the end of the year and while that's wonderful for one data point, it really doesn't drive what we want to do, it doesn't get the cash freed up throughout the year. It really doesn't help you on your long-term return on invested capital metrics. And so we have really put the attention and focus on doing better on working capital throughout the year and in fact we are changing our incentive plans for 2019, it could be an average rather than an endpoint. And so I think we should see demonstrated improvement quarter-over-quarter on the working capital metrics throughout 2019.

Okay great and then maybe just one housekeeping. You mentioned in the release normal seasonality of the business, but it does sound like the savings may be further in towards the back half, is there any framework you can give us or guide post be it percent of the year first half, second half to help us calibrate things here for Q1, Q2?

Sure. What we said and I will just reinforce is that, I would use 2018 as the guidepost for earnings and cash. Our expectation is that year-over-year each quarter you will see an improvement and I would use that as the baseline. The other thing I would just kind of maybe highlight from a modeling standpoint, and Scott hit on this a little bit earlier, we acknowledge at the first quarter of 2018 we did not have a - we had horrendous cash working capital quarter. We know that going into the first quarter of this year there is some seasonal bill, but we don’t expect it to be to the full extent that happened last year. We are as Scott mentioned, we put quarterly cards in place, we have an eye on it, we talk about it, in January we are talking about in February that we cannot have this huge outflow of cash in the first quarter like we did last year.

Okay, great. I appreciate the color.

Our next question comes from Nathan Jones from Stifel. Please go ahead.

Good morning everyone. Going back to a few questions here on the bookings. Aftermarket bookings at nearly $550 million in the quarter is pretty close back to previous peak levels on the aftermarket bookings side. You guys have talked about commercial excellence initiatives to try and drive better penetration into your current installed base. Can you maybe talk about if you're seeing any benefit from that or if getting back to this level is purely market lift and potentially there is some further upside from these commercial excellence initiatives or if that's already started to be embedded in this bookings number?

Yes. The initiatives within the transformation is called commercial intensity and we are defiantly seeing an uplift due to commercial intensity. So it’s both the internal efforts combined with some release of MRO and maintenance spending at the largest installations. So I don't know, it’s hard to say is it 50/50, is it 70/30, but it definitely is a combination of the internal efforts and the market. And what I would say is we have got really good visibility and I showed this example in December where we have a pilot in a target account, we are tracking to the uplift that I shared in December at those specific sites, which is mid-teens type growth improvement. So we have validated that, this commercial intensity program is incredibly effective and like I said in December, there is really nothing novel or innovative about this, but it really is providing structure and process for our leaders out in the field to make sure that we are fully capitalizing on our installed base and in our service capability. So just by doing that and putting this operating system in place, we are seeing this healthy uplift. We are not going to get that across every single location, but for the sites that we have designated as this is an opportunity, we are seeing the demonstrated kind of a mid-teens growth. And so I would expect that to continue throughout 2019 and I said this is a little bit earlier, but North America we have gone live, we have now gone live in Europe and we are probably at about 60% deployment and we have just started the process in Asia Pacific and the Middle East. But we are getting good uptick, the team is incredibly focused and I think really what it does is it put that aftermarket group now very focused and aligned to growth rather than just focusing on the margins and the delivery.

Okay. So that sounds like you think that there is upside on the aftermarket side to where the previous peak levels came in. On the OE project side, I mean, when we are in 2016, when you start getting these $5 million to $15 million or $15 million to $30 million projects, there is generally not a whole lot of margin associated with those and they absorb fixed costs. As we are coming out into a better demand environment, are you starting to see the margin profile that you can bid these projects had improved? Are you starting to see pricing on these things improve? Do we still need to soak up more industry capacity before you can really start to see those move?

Yes. it’s a fair and a good question. And historically you are right, on large projects you attract a lot of attention, then there is a lot of different bidders for the EPC forcing the pricing down. Again, I said this a little bit earlier, we are very focused on moving our margins up and we are not afraid to walk away from something that's not going to meet our margin threshold or the margin that we think we deserve or we are booking and executing these larger type work. And so, we have turned work away and we are going to target areas and we are going to target partners where we know we can make the margins that we need to make. And when we look at the project portfolio and the things that we are tracking to in 2019 they all have a higher margin than what we have accepted over the last couple of years at Flowserve.

Okay. Maybe just a quick one on the backlog quality. I'm sure you don't want to talk about what the exact margin and kind of things are in backlog. But could you maybe talk a little bit about how much better that margin is in backlog now and at the end of 2018 than they were at the end of 2017? And if you expect that quality in backlog, that margin profile in backlog to continue to improve as we go through 2019?

Yes. So Nathan, I'm not going to give any numbers on that. But it's certainly implied in the guidance right and so you can see in the guidance that we are uplifting the margin percentage with where we likely ended on the EPS guidance. And I said this a little bit earlier, but we have really started to be selective and focused on margin in our backlog and really focused on pricing at the beginning of 2018. And I would say throughout the year, we got better and better and so every quarter we have been able to get more confident in building that margin in backlog. And so we have got some pretty good momentum here. And I would say - what I'm talking about is it really applies more on the pump side than the valve side because which is the valves have historically kept reasonably good margins even throughout the cycle. But on the pump side, we definitely expect to continue to expand margins given what we booked thus far and I don't see that changing here at the beginning of 2019.

Okay, that’s helpful. Thanks very much for taking my questions.

Thanks Nathan.

Our next question comes from Charley Brady from SunTrust. Please go ahead.

Hey, thanks. good morning. Just kind of background on Nathans questions on the large projects out there. I guess more - kind of medium-sized projects. We are just hearing that the pricing competitiveness is still really, really tough out there and relative to what a normal margin might be considered, it’s still maybe anywhere from 500 to 700 basis points delta. I’m just wondering is that something you are still seeing, is that pressure lessening in all or is it is more confined in certain area than other areas, you are really not seeing that sort of pressure.

Yes. There is defiantly pricing pressure out there and what I would say is when you get an EPC that’s launching five different bidding process and we have got a bunch of people competing then the margins are not going to be very good. Where we have some proprietary technology and we are able to leverage that and then selectively add in other pumps and valves around that, then our margin profile moves up and it's in a much better place. And so part of our efforts within the transformation is to really get more proactive about our planning. when I talked about sales and operational planning before, but we have implemented now our CRM system, we now have global visibility to demand and we have got a much better understanding of where capacity our capacity is and so we can make more informed decisions and be more selective about what we want to take and not want to take. And so while some of these projects are going to command or get a lot of attention from our competitors and drive prices down, we are not necessary going to compromise on that and we are going to go find the ones where we think we can make the right money and where we can provide either the right solution or the right technology that brings Flowserve the value that it deserves in these projects. Now the other thing I would say is, I’m thinking more on the pump side here, if we look across the peer group and where folks are, we are starting to see some capacity fill up and I would expect the pricing should continue to improve throughout 2019, but what I would say is there are still projects and some activity out there that is not what I would have expected because I would have expected more discipline on pricing with the peer group peer at the end of 2018 than we saw.

Scott that’s really helpful, thanks. And then just one more for me on IPD. So the margin obviously in the quarter was a lot higher than we expected and then you come from that. I’m just trying to understand how much of that I guess margin lift was due just from flushing out the past due backlog versus I guess the core business operations for lack of a better term.

Yes. I don’t want to give in too many specifics, but I mean clearly it was a combination of all three things, right. It was the margin improvement, there was definitely some seasonality with the fourth quarter just in fact that we are so focused on end of year rather than all quarters, we had a little bit of that and then we have got some operational improvement and then we had this divestiture that was a losing margin business that came out of the system. And just the combination of all of that and then back to what I said earlier, just the blocking and tackling and the basic fundamentals of running a business in a proper manner is allowing us now to get our margins into much healthier place. What I would say is, 10% was better than we had expected, we had been saying kind of mid to high single digit and so we defiantly had some wins in the quarter, but we feel really good about the sustainability in 2019 over the full-year to continue to grow the full-year margins within that platform.

Alright. Thank you.

Our next question comes from Joe Giordano from Cowen. Please go ahead.

Hey guys, good afternoon. So I just want to start on cash. In the quarter I think on the operating cash flow side, some of the variance versus where many of us might have been seem to be unlike the accrued liability stays on rather than like a traditional working capital account. So one is there anything like we should know in that account going forward? And then Lee just like on your longer term 100% conversion how should we think about that? There is obviously a big move from where we are today. Like how linear should that kind of be? Or is it going to be kind of a step change towards as we get closer 2022? How do you kind of foresee that?

So let me answer the second question first. So I think one of the things on cash conversion that we are trying to improve upon is I would say is first the gap between reported and adjusted earnings. As part of my prepared remarks, I highlighted that right now roughly adjusted - adjustments roughly around $55 million. That is significantly lower than where it’s been. So the first thing is really trying to improve the quality of earnings and have fewer adjustments. So that’s part of it. The second part of it is obviously the working capital performance, and just continue to expanding our margins. So I wouldn’t necessarily say its linear, but we expect to do significantly better in 2019 than we did in 2018 and just having fewer adjustments to the step in the right direction. And as I talk about earlier, improving our working capital performance is also another step in that. So we hope to get there sooner. We are not waiting till 2022 to get the 100%, but we are going to be - we are looking to make it I would say a relatively step function improvement in 2019 and 2020.

Okay. And was there anything in that accrued kind of category that need to...

Yes, I mean there was some adjustment around pensions, the discount rate change and that lowered some of our liabilities, but it really didn't have I would say an immediate P&L impact. The discount rates lowered that liability and there has been some adjustments around some environmental accruals and so forth. So I wouldn't point to something that is significant.

Okay. And then on margin. I mean two things here. One on IPD, obviously we don't want to get in a situation where it's a big surprise positively in 4Q and then it sets up to be a surprise negatively in 1Q just given where we are coming from on a comp basis. So historically it looks like 200 to 300 basis point kind of sequential move from 4Q to 1Q it seems like an average before things kind of went haywire. How would you kind of handicap that now? And then like broadly with margins, I just want to get a sense of what kind of savings are you baking in into your 2019 from like the restructuring efforts, I guess the incremental inclusive of savings seem fairly modest given that kind of organic growth. I'm just trying to gauge your conservatism in that margin number.

Yes. So let me talk about the first quarter first. And Lee said this earlier, I think as you think about our earnings and revenue over the different quarters, I think using 2018 is the good go by in terms of what to think about. On IPD specifically, it was a big quarter as what we had expected. And Q1 will not be as good, and so it’s going to come down, I'm not going to give you exact number, but it will definitely come down. But when we think about year-over-year, we do expect to continue to grow the IPD margins and quite frankly all of the platform margins. And then the second half of the question was - remind me what did you want in the second half there, was that more on the full-year right?

Yes, I was just curiously like in your earnings guidance, how much like savings are you baking in from like the restructuring efforts that you have done in 2018 and you are planning on doing in 2019. This is like incremental theme even at the high end below 40% or so. It seems conservative based on the 6% to 8% organic growth for you guys, I'm just trying to…

Yes. That’s a fair question. I will just say, the way I look at it I is like a EPS from 2018 to kind of what we are guiding at the midpoint and its a 17% growth and so that doesn’t feel conservative at all to me. I get where you are going when you kind of back into that incremental margin and what the basis points improvement is. But what I would say is, we feel pretty good about the guidance, we think it is aggressive, but we also think its achievable. We said this a little bit last year right, we are not going to put something out that we don’t think we can make and quite frankly our internal plans and everything that we are trying to do would be higher than what we are putting out in the guidance for 2019. But we have got a lot of good momentum, we are doing the right things and if we can move margins up higher and at a faster rate than we are not going to let off of that. Everything is wired around the transformation program, right so the pricing work stream, the operational work streams is around supply chain, cost takeout and the other things are all in full-motion and we are going to execute those as fast and as furious as we can throughout the your 2019. We are making good progress on this.

Thanks guys.

Our next question comes from Josh Pokrzywinski from Morgan Stanley. Please go ahead.

Hi good morning guys or I guess good afternoon. Thanks for fitting me in. just got a lot of grounds uncovered already, but I guess one thing that sticks out on some of your aftermarket commentary is that I think we came off a pretty strong second half in 2018 in terms of turnaround activity in refineries, the calendar looks good for the first half of 2019 as well. But I would imagine at some point you hit tough comps, is that part of some of that second half apprehension in MRO sustainability?

Yes. I think that certainly factored in, and then just quite frankly we just don’t have the long-term visibility on MRO spending, right. We don’t get a lot of communication here and hard to track it. Like I said earlier, what we hope though is that the market and the spending levels increase and than what we do know is that our commercial intensity program are going to drive your growth above what we have had historically and expand our market share of what we have from the installed base. So we have got that working for us and quite frankly just the question is from an customer standpoint how much spending and availability is there in the back half of 2019.

And I guess that’s kind of the corner at the center of the question is are you getting a sense in the marketplace that customers have caught up from unsustainably low levels of spending to where they are overspending near-term and growing from this level is not as obvious.

No. That’s not what I said, let me be really clear. You know everything we are seeing right now points to continued growth. Right the fourth quarter is good, the data point in the first quarter is solid. And so we fully expect that MRO spending maintains or continues to grow. What I’m just implying is like if there were risk and pulling us down to the lower side of what we guided, then it could potentially be a slowdown in the 2019 MRO, back half for the year MRO spending. But right now, we are not seeing that, we are not seeing it, but we just don’t have that visibility that it continues in the back half of 2019.

Got it, that’s helpful. And then just one question for Lee around free cash. Lee I assume that you guys are call it working capital neutral, which would be some good progress given the level of growth that you're expecting in 2019. Just between restructuring and pension that it kind of brings down to somewhere in the neighborhood of 75% conversion, is that a good starting point or is there anything else on discrete lines that we should be aware of?

I think our aspiration is to be better than that.

Okay. Got it.

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. And you may now disconnect