Flowserve Corporation (FLS) Earnings Call Transcript & Summary

Got it. And then just switching over to Flowserve 2.0, kind of more broadly. You mentioned in some of your earlier comments about reducing the number of ERPs. I recall you're pretty early in the outlining of that plan. All these P&LS and ERPs that were scattered throughout the organization looked like hundreds of brands up on the chart. How has that process gone? If you want to use the baseball analogy for what inning you think we're in on that kind of rationalization? How would you characterize that?

Yes. So I'll use the baseball analogy for the overall Flowserve transformation. And so we said we were -- at the beginning of this year, we're about halfway done. And I'd say we've made some more progress now. And so we're, I don't know, 55%, 60% through the transformation. And so we made really good -- this is part of my opening remarks. So I'm very pleased with the progress we've made even since March on lots of things. And so the ERP is one thing. And so our landscape on ERP is incredibly challenged. We've got over 40 different systems, and a lot of them are unsupported or cost us a ton of money to support. And what we were able to do this year and we started this in earnest last year is we created a standard template for the future in terms of what we want to do. A lot of that using the latest cloud technology in one of our big service providers. So I don't really want to name, but we're locking in on one provider. And well, what we found is while we don't need to blanket and do a wholesale 5-year ERP conversion process, what we can do is have 1 system that kind of sits in the cloud and we push things up to it. And when we start to migrate to a cluster of different ERP systems that can support that. And so what we've done this year is we validated our standard design, we've had our cloud setup up and operational. And then we've done one of our largest facilities. We did a whole scale conversion at the end of Q1 and Q2. And what we're seeing is that the benefits of doing that and getting rid of some of these legacy systems are what we expected and that we can drive further cost out and further productivity at that operating level. And so we're now about to kind of ramp up this program. We will start systematically eliminating things, drive to these kind of 3 clusters of systems. And ultimately, what we want is kind of an enterprise-led IT strategy and IT architecture and the design is in place now. We validated our first 3 pilots on different operating models, and I feel really good with: one, the progress that we've made; but two, the direction that we're heading here.

Got it. And then I guess just taking a step back on Flowserve 2.0 and looking at some of the broader margin targets that you laid out a couple of years ago. How much of the path to those margins would you consider to be kind of cost takeout versus operating leverage? And I understand that since then, obviously, we've had to COVID, and you've also taken out a good amount of restructuring costs as of early 2Q. So putting all that in the mix, how do you see the path to some of those longer-term margin targets?

Yes. I mean mostly those margin targets were around -- I think a lot of it was cost takeout. Some of it was pricing. We had our design to value, which is basically a redesigning, like legacy designs. We had manufacturing productivity in there with supply chain in there. And so most of it was around optimizing product costs, really thinking through the way we manufacture and lean out our facilities. There was pricing optimization and -- but I don't think we'd put a whole lot of leverage into those targets. And just as a reminder for folks, at the end of 2018, we launched kind of a 4-year program and said, here are our long-term aspirations and targets, which were pretty sporty. And they are certainly a lot higher than where we were in 2018. And we've made really good progress on that, right? And so now with COVID and some of the issues on the market coming down, I think it's going to be harder to achieve that. And our plan is at the end of this year, we'll kind of relook things, we'll take stock of where we're at, we'll look through the transformation opportunities and then decide what we do with that guidance. But I'll just say, Josh, today, I'm not ready to give up on those targets. I think our time line might not be what it was before, but I still think for this type of business, generating 100% of free cash flow is important. I think 15% ROIC is important. I think 15% OI is important. So all of those things that we put before are still very much in the grasp. And I, quite frankly, don't want to give up on those. And as we look through the transformation, things that we're still working on, there's a ton of opportunities out there still. And so I just think we've got to re -- take stock again and we'll come back with kind of our official position there. But I don't think we're going to -- we're not going to back off too much, and we're certainly still -- today, we're aspiring to achieve those type of levels.

Got it. I think one of the paths we're getting there, you mentioned a few things on price and supply chain and the design to value. I think on the market side or the revenue side, there was an attachment rate or aftermarket capture opportunity that you talked about. And I think you listed out all the QRCs and where those were located. How has that progress been? Because the aftermarket is something, I think folks have a harder time tracking. You can't just look at turnaround schedules and certainly share ends up being a little easier to move around in the short term. Maybe just how has that strategy been deployed? How satisfied are you with how you've done so far? And what should we think about as kind of the next step from here?

Yes. So the program you're referring to, we call it commercial intensity. And essentially, what it is, is just getting more of the market share of our installed base with the customers that we work with. So if you think of 1 QRC and so pick Gulf of Mexico, Corpus Christi, we've got QRC complex there that supports our pumps, valves and seals. And there are 7 different major installations. What we're trying to do is make sure that we've got that proper playbook to get more of our entitlement and capture more of the spin with the customers in that region. And so that playbook is now deployed globally, and it just starts with some of the basic things like market segmentation and touch time with our customers and tiered offerings and just it's -- basic is not the right word, but I would say it's a lot of blocking and tackling some of the things we were doing before and others, we weren't. But it's a playbook that we know can drive results and get more spend out of our customers. And so pre COVID, we were making really good progress on this and was very pleased, and I get regular status update around the world. And as I visit QRCs, we review kind of their commercial intensity rollout in how they're executing against the metrics in the scorecard. But I think the COVID has definitely taken some -- slowed the momentum of our progress there. And so I would expect as operators start to let us back into their sites and as we start to engage and interact again, then that's going to start to pick up. But this is a really important initiative for us. Aftermarket makes up about 50% of our business and the more -- it's obviously good margins as well. And so the more we can be involved in their operations, their uptime, helping with their maintenance, the better off we're going to be. And so this is going to remain an initiative as we go forward. It's a big part of 2020, and it will certainly be a big part of what we're doing next year.

Got it. And then you mentioned the role that the pipe plays as part of the broader strategy. Obviously, nothing happens in a vacuum. Given some of the gyrations in the market, have you seen pricing discipline among some of the other market competitors get a little bit more lax? I know for you guys, you've been more -- a lot more laser-focused in the past couple of years, but any changes that you would point to outside of kind of your own 4 walls?

Yes. So I think we've done a really good job over the last couple of years on pricing. We -- I'm not going to say we've been the market leader, but we've certainly been aggressive on walking it up. And quite frankly, we needed it to do it. With COVID in the market turning down, it's difficult out there right now. And so I'm not saying anyone's undisciplined or doing things that they shouldn't be doing, but it's competitive. And so I'd say, certainly on the OE pump side, where the bookings and the activity level has dropped significantly, that's where we're seeing the most pressure. And so for us, it's making sure that we're making good decisions that support the gross margin of the product, but also looking at the absorption of our manufacturing facilities as well. And so we're sharpening our pencils on there. And then two is just really making sure that we're driving the cost out of the product as best we can. And so on the supply chain side, we are seeing some favorability there on our materials in some of the components that we buy. And so it's getting the best deals on our goods that go into making our products and services. But then we've got -- we've just got to make sure on the bigger picture on manufacturing that we're as productive and as efficient as possible. And if we can do that, then we can make money even at today's pricing. But I would suspect also, I'd just say, Q2 is crazy, right? I mean so if we had COVID hit, you had markets implode, everyone's working from home and there's just a lot of things going on. And I would say, I think things are more stable -- I know things are significantly more stable today. I'm not going to say we're seeing better pricing on OE pumps, but I don't think we're going to see the trends that we certainly got into in Q2. So I think we get better on pricing on OE pumps as we go forward. Now what I would say is on valves and on our aftermarket business and our seal business, while we are seeing some pricing pressures and dynamics in the marketplace, it really hasn't been too concerning at this point.

Got it. Got it. That's helpful. And then just shifting to something as maybe a bit more of a longer-term dynamic. The topic of near shoring, I think, with some supply chain interruptions that have happened as a result of COVID and certainly a couple of years now with tariffs that you're seeing more of that being discussed, I think, in some cases, moves starting to happen. But I think a lot of people associate that more with kind of discrete good production and maybe less with the process world. Is there anything in kind of chemicals or pharma or any of the other end markets you touch where the supply chain could move a little bit closer to the regions where those products are consumed? And do you think there's an opportunity for Flowserve within that? Obviously, you guys are a pretty global business and manufacturer everywhere as it is, but it's more of what your customers would be buying?

Yes. So I'll just start with the Flowserve position, I'll answer with regard to that. We are incredibly global, and we've got a regional footprint. And it's how we manage our operations. And so 60% of our manufacturing and our head count is outside of North America. So it gives us a pretty good position to support whatever that -- however the trends in those local market buying decisions go. And so I feel really good about -- we can serve China for China. We've got India in India. We've got probably more in Europe than we need, but we've got Europe into Europe and exporting around the world. And then we certainly have operations in North and South America. So I think we're going to be incredibly well positioned for whatever happens on -- one on geopolitical landscape and then two on whether or not customers make more local buying decisions. What I would say, though, in our industry is there's been a lot of that already. And certainly, on the aftermarket and the service side, the facilities that we support like a refinery or a specialty chemical plant, they want that support very local. And so the QRC network, it's really important to be in close proximity and speed is everything, right? You've got to provide a high level of service on the quotations and the turnaround and getting our service techs out to their sites. So I think we're well positioned. I think there could be a little bit of a change where folks are looking to buy more local, but I don't think -- I don't see anything dramatically different from a year ago. And local content and local support has always been a big part about the process industries for us supplying equipment to them. But again, we're well positioned for regardless of what happened. And what we're continuing to do is make sure that we've got the talent and the capabilities in all of these regions to continue to support those operations.

Got it. That's helpful. And then one of the big initiatives out of Flowserve 2.0 that I think people were able to see early on was the improved cash generation. And I know that's still a target you want to maintain and deliver against over time. So as you've never really done, but the cash generation has improved the balance sheet in pretty decent shape. At what point, Scott, do you start to think about external deployment and maybe you return to M&A. I know you're kind of decluttering the portfolio and getting some of these ERPs consolidated. It doesn't exactly sound appealing to then add more complexity from a new asset. But you're either thinking about end market diversity or gaps in the portfolio you'd want to fill. Is there something that you want to see first before that moves up the priority list?

Yes. Sure. And so I mean, you said it exactly, Josh, right. So one was we had to get our cash flow, cash generation and balance sheet where we need it. We've made good progress on that. We're not quite where we need to be, and there's still tremendous opportunity on our working capital efficiency, which we're very focused on. So I'm pleased with the progress we've made, but I think there's equal opportunity is the amount of progress we've made in my 3 years here. And so we're still very focused on that. Then the other thing on the M&A front is, if you are going to go out and buy something, I'm a big believer in conducting proper integrations, doing it quickly, having a deliberate plan and getting that business into your operating model as soon as possible. And part of Flowserve 2.0 is to create that operating model. And so for me, in the first couple of years trying to do a deal and thinking about how to successfully integrate it was just, quite frankly, it just wasn't going to happen. But I feel really good about the progress that we've made. Again, we've now got that ERP standard template. And we've got playbooks now for operations and commercial and basically have defined the way that we want to run our company. And so I feel reasonably good about our ability to integrate a deal today. And that is probably the single biggest inhibitor for us to do anything inorganically. Now with that said, what we can't do is go out and stress our balance sheet, we don't want to do that. And we certainly can't go out and do something that's going to be incredibly complex where you're picking up an asset that's got operations in multiple countries and 4 or more ERP systems. So that's not going to work either. But I think there are opportunities out there that would fill each technologies for us or expand into markets that were not necessarily as concentrated as we want to or potentially a geographic fit that helps us support our customers even more. And so I would say we're actively looking. I would say we're not out there making tons of calls about we've got to do a deal this year. But for the right thing, then we start to get excited about it. And then obviously, it's got to create value for our shareholders, and we're incredibly focused on that. And so if all of those things check out, I think you could see us start to do some smaller things around the M&A front that really help position folks for long-term success and value creation.

Excellent. Well, I appreciate that color, Scott. And I see we're at time, so we'll leave it here. Scott, Jay, thanks to both of you for spending the time here today. I hope everyone is safe and well, and we'll do this all again next year, but hopefully, with a bit more sun and sand.

We hope so, Josh. Thank you for having us today.

Thanks, Josh. You do well.