Flowserve Corporation (FLS) Earnings Call Transcript & Summary

All right. Good afternoon, everyone. Thank you again for joining us here virtually at the 26th Annual Energy Summit. We're very pleased to be joined by Flowserve. With me is Flowserve's President and CEO, Scott Rowe. He has a couple of prepared slides around what Flowserve's doing to help the energy transition, and then we'll be heading into Q&A. So with that, I'd like to hand the floor over to Scott.

Great. Thank you, John, and really appreciate you having us here today and especially at the Energy Summit. And it's a conference I've participated in the past and very happy and fortunate to be back. So today, I really want to talk about energy transition and Flowserve's role in energy transition. And so -- sorry, I'm bouncing around on slides here. So first, we've got some forward-looking statements. I'm not going to read through all of this. I think most of the investors are familiar with them. And we're also broadcasting live today and so that will go out on the web. But for those that don't know Flowserve, this is Flowserve at a glance. We operate globally. We have a portfolio of flow control solutions, primarily pumps, valves and mechanical seals. And we've got a committed and dedicated workforce of 16,000 people. But again, today, I really want to focus on what we're doing to support our customers as we go through the energy transition. And so energy transition means a lot of things to a lot of different people. For Flowserve, we've got a committed customer base and a massive installed base of pumps and valves all over the world. And we want to make sure that we're there in the energy markets that we participate in today. And so for us, today, our business is about 40% on the downstream in the oil and gas side. And when we think about the investment and what's needed for energy in the future, that's not going to go away in the decades to come. And so what you can see on this slide is the investment needed by 2030, right, so just 9 years away; and then the investment needed by 2050. And what you see is it's going to require a combination of the existing fossil fuels, right, so oil and natural gas and others, but then a significant growth in renewable energy. And so that's what I really want to talk about, is how Flowserve can participate today and continue to support our customers but also work into the future. And then the blue area on the bottom right here is a really important one, I'm going to talk about this more, but it's the investment in energy efficiency. So taking today's assets and making them more efficient in the future. And we think there's a big prize for Flowserve by capitalizing on the dollars that will go into energy investment. And so like I said, right, today's customer base here on the left is a very substantial list of major names in the oil and gas business, in the power business, chemicals and general industries. We support a broad portfolio of end markets, and we can put pumps, valves and seals in pretty much any flow control application. And we've been doing this for over 200 years. And so if you think about the last 2 centuries, the changes and the dynamics in the different marketplaces that we serve, and we've been able to grow, survive and thrive in all of those changes. And we're confident that as energy transitions into renewables and emissions reductions and decarbonization, that we'll continue to support today's customers and enable them to work through energy transition. And here's the -- we call this the puzzle pieces for us. And so at the bottom are today's energy solutions, right, the oil, gas, coal and nuclear. We participate in all of these end markets today. And then the green is the energy of tomorrow. And what we want to be able to do is take the capabilities that we have in flow control and leverage those as folks are investing in the new green or the energy solutions of tomorrow. And we think we can do this across 5 major areas. So these are the pathways or the pillars where Flowserve can participate. And I'll just kind of walk across each one of them and talk about what we're doing. And so energy efficiency, again, is going to be a major and significant investment area. And we've got a nice portfolio of different products around energy recovery devices, our RedRaven IoT, which are all geared to taking energy and cost out of existing operations. And then on clean and renewable energies, there's concentrated solar power, there's chemicals and there's other new technologies where we're already playing a role today. And we believe we can continue to play a role in the future. And then the middle one is greenhouse gas emissions reduction. Obviously, this is a very hot topic, and we can participate here with carbon capture and sequestrations and further emissions controls with our seals and our future of emissions valves and standards. And then decarbonization, again another hot topic in today's discussions around energy transition. And we can do this by supporting the hydrogen economy. We can do it with coal to natural gas, and we can do it in some other tech process technologies that we're working with customers in today. And then finally, on sustainability, right? We can do our own part on making the world more sustainable but also helping our customers with different solutions on biodegradables and biofuels, which again, we're participating at today but maybe not in as big of a fashion as we can in the future. And so really, what I want to do next is spotlight 3 of these where we actually have products and technology today, and where we think we can do a lot more as the investment grows in these spaces. So first, I want to touch on energy efficiency and energy recovery devices. And so within the Flowserve portfolio, we've got energy recovery pumps that are currently used in acid gas removal. We've also got energy recovery devices, we call it DWEER, is our brand name where we go to market there, that recovers energy in desalination and water projects. And then also IoT, which is our new RedRaven announcement and launch. RedRaven essentially is monitoring existing installations. And so what we've done is been able to instrument our pumps, valves and seals, pool that data into something that's now meaningful for our operators and our customers. And then our customers can drive efficiencies and more productivity because they have the right flow control data, and we're providing our expertise from our algorithms to help them make better choices on their operations. And then the next one I want to spotlight is clean and renewable energy. And so concentrated solar power is a big part of the future. And I'm proud to say that Flowserve has been doing concentrated solar power now for over a decade. We've got pumps, valves and seals that all participate in this market. There's many projects all over the world, and we've been a leading provider of equipment. In addition to that, we're partnering with some government agencies and different foreign entities around how to make the future of concentrated solar power even more efficient and bringing that cost in line with other sources of energy. So this is an area that we've got a lot of expertise. We've done a lot of development, and we believe we're in a really good spot to continue to capitalize on concentrated solar power. And then last of the 3 spotlights is greenhouse gas emissions reduction and blue hydrogen and carbon capture. So blue hydrogen is obviously one that a lot of people talk about. And essentially what that is, is steam methane reforming or using natural gas -- or making hydrogen from natural gas. And today, Flowserve is doing that in fertilizer production facilities, and we're doing it in refining. And so we've got products and technology that are already doing steam methane reforming. In addition to that, if you add the carbon capture, that's when you get to blue hydrogen. And so again, today, Flowserve is doing carbon capture and carbon sequestration. We're doing it with some of our top refining customers. The technology we use here is the SIHI liquid ring compressor in a skid that extracts carbon from a process and reinjects it back in the process. And so we believe that the combination of what we're doing in steam methane reforming with carbon capture today will allow us to be a player with blue hydrogen in the future. And so while today, it's not a big source of energy, we believe there's going to be significant investment and significant technology on this. And we believe we can take our flow control products and solutions to this application. And so John, just in closing, we've got 200-plus years of working through complex flow control challenges in multiple industries, right? Whether it's water or general industries, oil or natural gas, power, we've been there. And we believe we can leverage this portfolio, our people, our expertise and our products just to help our customers work through energy transition. And we're not going to leave our customers today, right? We've got a great customer book. We've got an incredible installed base. 50% of our revenues come from that installed base. We're going to support them today, and we're going to support them on their journey through energy transition. And then we're going to continue to do our part. Earlier -- or mid last year, we announced our carbon emissions targets. We'll continue to move on that path and reduce our own footprint. But I think even more importantly and where we can make a bigger impact is helping our customers reduce their carbon footprint. So we've got a lot of focus on doing that. And then finally, Flowserve has the products, the services and the technology to be a leader throughout energy transition. And so John, that's all I had, and I'll stop sharing here. But we're happy to entertain any questions.

Great. Appreciate those slides. Very helpful in terms of seeing the product and hearing about the applications. Maybe the first question related to energy transition. You hit on a couple of kind of big areas, whether it was solar, carbon capture, hydrogen, desalination. Is there any kind of dollar or Flowserve dollar value per content you can put around a typical project, understanding that a lot of what you do is engineered?

Yes. They're all different, John, unfortunately, and it really depends on the size of like -- so on concentrated solar power, it depends on how much power they're looking to produce. And I'll just say our biggest awards in that space have been upwards of $40 million and $50 million. But I'd say a typical concentrated solar power plant for us would be kind of $10 million, and so that would be one. And some of the carbon capture stuff that we're doing, a big skid and helping them on something would be roughly $10 million. And so I think these are all relatively small, but as the investment grows and as folks are committed to doing this on a broader scale, we do think there's a meaningful opportunity for us that -- for value creation at Flowserve. But today, that investment is just -- it's not at the level that's going to drive -- today is not at the level that's making up a majority of our revenue or our earnings.

Great. And then as we think about that hydrogen opportunity, is the opportunity for Flowserve more on the utility side, the mobility side of hydrogen, right? It spans a lot of different use cases. So where do you really see yourself playing on that kind of hydrogen part of the market?

Yes. So Flowserve at its core is a flow control company, right? So we get excited about helping operators with their flow of liquids or gases. And so that's what we're going to play in. We're going to play in the processing side or the creation of hydrogen. And so today, steam methane reforming, we're already doing that, and we're helping customers both from fertilization and in refinery to make hydrogen. And as the technology and the process evolves to make hydrogen more efficiently, we believe we can be, one, we can support those efforts in development and process design; but two, we think we can put our pumps, our valves and our seals in whatever that process is. But that's, I'd say, the near-term opportunity. I don't see us, at this point, taking that leap into the storage of hydrogen or the potential conversion of that into the electricity side. But certainly on the generation, the processing side, we believe we can play a meaningful role.

Great. And then one of the things you started to talk about, I guess, now maybe it's been 2 quarters, is feeling comfortable that the organization is in a spot where you can start looking at inorganic investments. So as you look at your pipeline and think about the energy transition, can you do it with everything you have organically? Or are there additional organic investments or inorganic investments that could accelerate it?

Yes. No, we certainly want to be investing in this space and we don't have all of the pieces today, and I spotlighted the things that we do have. But there are also technologies and products that we want to round out our portfolio. And so our new product development effort is -- will be focused on attractive markets, an area that we think will grow for us. And then we also think, as we open up the M&A funnel and start to look at other companies, this will be an area of focus for us as well.

Great. And then maybe shifting to that energy efficiency side. You talked about RedRaven, right, recently announced IoT platform. As I understand it right, I think Flowserve has been in the IoT game for -- prior to just the announcement of RedRaven. But what's really different or distinguishes RedRaven from what Flowserve was doing before or maybe from what some of your competitors might be doing in that kind of asset health monitoring and IoT space?

Sure. Yes, it's a good question and we're really excited about what we're doing with RedRaven. And John, as you said, we've been instrumenting pumps for many years now. It's been over 10 years. But I would say at the beginning, it really was around just collection of the data. And what's different now is we've partnered with a large number of our customers. We've got years and years now of data collection. And I mean, I can't even count the number of data points that we're pulling in. It's a large number and I'm going to mess it up. But we've got lots of history now, and we've been able to take that knowledge and the expertise that we've had over our flow control history and really make some meaning and some sense out of that data collection. And so now we're not only monitoring our assets but we can also move into a predictive mode as well. And so when we think about preventive maintenance, we've already predicted failures of different pieces of equipment in a lot of our pilots. And so when we think about RedRaven, this is the point where all of that information comes together. But it's not information anymore, it's actually -- it's actionable information in data. And so within the platform, we can say, "Hey, you've got an issue here and here's our recommendation." And so we can see if there's a problem, we can predict when we think there's going to be a problem, and we can provide a solution. Whether it's changing out a shaft or there's a vibration issue or there's a flow issue, whatever their problem is, we can point to that and help them avoid unplanned downtime and drive higher productivity. And I think that's where we can differentiate even with the peer group is we're now instrumenting our valve portfolio, our pump portfolio. We can do it on our seal system. And we've got a far more comprehensive view of the whole flow control spectrum than anybody else. And so again, we're excited about what we're doing on RedRaven. We've been in pretty substantial testing ever since I've been at Flowserve, which is the last 4 years. We've got great partnerships with our customers. We've got great partners with third parties on the technology side. And we finally got to the point where we were super comfortable to launch this publicly in more of a splashy manner. And so far, it's been just under a month. We're getting great response from our customers. We're getting a lot of inquiries, and we think we can at least double our installed base in 2021 as we go forward.

Great. And so then, I guess a couple of follow-ons to that. One, how are you monetizing RedRaven? Is this -- does it require a new device that might be more intelligent? Is there some type of subscription revenue to get at that domain expertise? How do we think about that?

Yes. No, that's a really good question, John. It's something that took us about 6 months to get to what -- how do we commercialize this thing? And how -- what's the best way to do it? And certainly, we want to bring value to Flowserve but we also want our operators to know that we're there to support them. And so originally, we were just selling the sensors and that's not what we want to be doing. And so now we're more on a subscription basis. And ultimately, what we want to be doing is moving to a sharing concept where we can commit with operators to productivity enhancement or mean time between failure or unplanned downtime. And we believe we've got the tools, the data and the expertise to take some risk in some of these contracts. And so ideally, we're going to move to more performance-based contracts with monitoring. And with that, we want to share in the upside, which we're confident that our system and tools can bring. But we'll also share in the downtime in the event that we can't do what we say we're going to do. And so right now, I'd say the contracts that we have right now are primarily subscription, and we're moving more and more into these performance-based contracts. And then the other thing that I really got to say because it's super important is, while putting our system and installing that on their critical assets and monitoring that site, that's one thing, and we want to get revenue from that and it's important to us. What we really want is we want to support our customers for the long run, right? We want to be right there. We want to have our QRCs and our service folks there. And we want to start to be able to pull through our pumps, our services and repair business right behind the monitoring. And so really, we see this as the front-end tool to really drive our aftermarket services and support and grow that business more aggressively than we have in the past.

Great. Maybe shifting gears here a little bit. Obviously, very tragic events following the storm in Texas. We get the question a lot from investors. Would love to hear what Flowserve's doing to help both your employees and your customers right now in Texas.

Sure. Let me start with the employees because we like to put people first at Flowserve. Unfortunately, in Texas, we've experienced a couple of these things with Hurricane Harvey and now a massive ice storm here 2 weeks ago. And so we do have an employee assistance program, and we've actually created a fund that allows the company to contribute, it allows other associates to contribute to it. And then folks that have had damage -- and unfortunately, there's a significant number of people in the Gulf Coast and Texas that had their homes damaged due to the freezing weather and some of the ice. And so they can actually take money out of that to offset some of their insurance deductibles or help them with some of the hardship that they're dealing with. And then obviously, we've been super flexible in making sure folks have time and resources. And we provided handing out water in a lot of our different QRCs to our associates to make sure that they had fresh water as well. And so I think we're through the most of that, but I'll say we do have a lot of associates with some pretty significant water damage from pipes bursting. And then on the customer side, it's really kind of similar, right? And so what we're tracking now is a list of over 30 installations. And when I say an installation, that would be a customer site, it could be a nuclear facility, it could be a coal-fired power plant, could be a specialty chemical plant, whatever it is. But we're tracking more than 30 of them that have an emergency request into us for some sort of pump valve or seal failure and that they need a quick response to. And so these are great opportunities for Flowserve. This is where we kind of shine because we've got proximity and great relationships with our customers. And we can commit to them that we're going to help them, very quickly, get their operations up and running again. And so we've got many of these stories ongoing. I don't know what the impact will be to Flowserve at this point. We lost about 4 days of production in our Gulf Coast facilities just shutting down due to the weather. But I'd say certainly, at this point, we feel it's a net positive. I don't -- at this point, I don't think it's going to be a substantial positive for us. But there's still damage assessments and things coming in. And so at the end of the day, I think it will be a little bit of help for us in -- as we kind of work through 2021.

Understood. And then there was a recent announcement came out from Flowserve talking about what you're doing in hybrid markets, which you've been getting a lot of attention from investors, that food and beverage, that pharma, life sciences vertical. You're doing something here with Pfizer. Maybe you could help us understand that relationship, and what you're doing there in terms of hybrid markets.

Yes. No, this is a great one, and we're super proud to be a partner with Pfizer and helping with the vaccine development and the production. And so just as background, we had been a LifeCycle agreement partner with Pfizer for a long time. And so they've got a facility in Kalamazoo, Michigan. It's in close proximity where we manufacture our seals, and we provide ongoing support to that through this LifeCycle Advantage. And so what that means is we're basically a partner there, and we support their operations. And we stock inventory and make sure that they can continue to be productive. And so we got a call kind of early 2020, saying, hey, we need some help with upgrades to seals, and this is really critical because it involves the COVID vaccine development. And we said, absolutely, we are 100% committed to helping anything that will get us through COVID. And so we actually provided some seals in the support of the development effort. And then later in the process, as they moved from development to production, we were actually to bring our -- be able to bring our full suite of equipment, both pumps, valves and seals into supporting the production of the vaccine. And so obviously, this is a major, major topic globally. It just shows the diversity of Flowserve and our products and the applications that we could be with. And we've been with Pfizer for decades now and this is just a great opportunity where Flowserve could provide more support and help them as they're working through a critical crisis, a global crisis and providing a vaccine and a solution to the world.

Great. And maybe just digging on that a little bit more. You touched on it a little bit in your answer, what a LifeCycle Advantage customer really means. It sounds like maybe there's a -- you have somebody on-site managing the inventory. But how many of these kind of LifeCycle Advantage customers do you have? Is this a way to get stickier with folks and drive the aftermarket business? Just maybe a little bit more about what really distinguishes the opportunity of a LifeCycle customer versus someone else.

Yes. So again, this is an aftermarket or a service contract that we have at existing sites. And we've done it on biomedical facilities. We do it in refining. We do it in lots of different applications. And essentially, it's saying, hey, Mr. Customer, we're here and we want to be able to provide the support that you need on an ongoing basis. And rather than just calling us for a part or a replacement on an ad hoc basis, let us come in and do the diagnostics and the assessment of your facility. Let us stock the inventory for you. And then this is kind of back to performance-based contracts. Most of our LifeCycle Advantage contracts are performance-based. And we track mean time between failure, we track uptime, we track delivery times. And when we do that, we can start to guarantee and say, hey, we're going to partner with you to help your operations be more productive and avoid unplanned failure. And so we've got many of these all over the world. It's something that we track very closely, and we track our wins on this and how many that we obtain on a regular basis. And our team is really good about -- with selling this, and quite frankly, the data speaks for itself. And what we can show is that pre-contract, these were your numbers and productivity and mean time between failure. And then with Flowserve after 6 months, 9 months, 12 months, 2 years, here are all the improvements and the savings. And so we document that with all of our customers, and we're seeing tremendous results. And so it's -- quite frankly, it's a relatively easy sell. I would say the majority of our LCA agreements are on the seal business. And what we've been doing, though, is trying to expand that into our pumps and valves as well, and so making a more holistic flow control contracts. And we believe in, tying this back to RedRaven, we believe, with RedRaven sitting on the front end, we can now expand our seal LCAs and start to pull in the pumps and the valves as well and provide a more holistic maintenance approach and more holistic ongoing operational support.

Very interesting. I guess thinking about the free cash flow, right? So you just reported your fourth quarter. I think that was a nice upside surprise relative to a lot of people's expectations. Then you guided 2021, 100% again, right, in excess of 100% of free cash flow conversion. I know your longer-term goal is to maintain that 100% conversion-plus. How do we think about maybe beyond 2021? I mean, there's a lot of folks at this conference talking about some projects coming back. Does that then put a headwind to your working capital? Can you -- so basically, can you sustain that 100%?

Yes. I don't think we can stay at 100% into perpetuity. And to your point, right, it really depends if we're -- in the down cycle, we'd come down. We should be generating more than 100%. So we did it in 2020. We fully expect to do it in 2021. As we start to pivot to growth and have to invest back in our business, whether it's capital or primary working capital, it's going to become more challenging. But what I can say is we still have significant opportunity to get our working capital in a better place. We finished the year in the high 20s. We really need to be in that low 20%. And so we've got to continue to make progress there, and it's primarily inventory. And I'm confident that our program and what we're doing will continue to provide some tailwind on cash flow as we kind of bring our inventory back in line and to where it needs to be. But I'd just say, John, in a cyclical business and through cycle, we want our working capital to be anywhere between 90% and 100%, maybe 85% before really a year that we've got to invest heavily back into the business. But as you well know, right, our company hasn't done this very well historically. And so we're in a much better place now. Our last 2 years have been in a level of performance that hasn't been there before. And we're confident that we can continue to drive this in the right direction. And we can keep this at an elevated level regardless of growth mode or a flat cycle.

Great. And then maybe just a quick follow-on to that. As you think about CapEx going forward, I know you've instilled a lot more discipline in the organization around capital projects. But some of the TAMs of these energy transition verticals you're talking about are quite big. Are you expecting having -- add roof lines or other types of capability to really get after that growth?

Yes. At this point, we feel -- we've done a good job taking the CapEx down below -- significantly below $100 million. There will be years where we have to come up $15 million, $20 million. But quite frankly, I don't see a scenario where we're back to the $120 million or $130 million. I see kind of $100 million is probably the ceiling right now. We've guided lower than that for 2021. And at this point, I don't expect anything different. We've got significant roof line. And if anything, we've got opportunity to continue to consolidate. And as our lean programs and our productivity programs work their way through the system, we're actually freeing up even more capacity with the facilities that we have. And so I feel pretty good about our capital guide for 2021, and I don't think that changes substantially. And then the only other thing I'd just say is the big focus in our capital program is our enterprise-wide IT systems and getting us far more efficient on a fewer number of systems. And so that's been a very challenging journey. We're making good progress, and even this year, we'll still invest. About 40% to 50% of our capital number will be on IT.

Great. I think that, that's a perfect place to leave it. So I'd like to thank everyone for joining us. I'd like to thank Scott for his time. And we hope that everyone stays safe and healthy, and look forward to following up with everybody. So thank you again.

Thank you, John. Thank you for everyone participating today.

Great. Take care, everybody. Bye.