Flowserve Corporation (FLS) Earnings Call Transcript & Summary

Hi, everyone. Good to see everyone again. Well, kind of, I guess. I don't see anyone else. You see me. But next up today, we have Flowserve. And with us, we're happy to have Scott Rowe, President and CEO. If anyone has questions along the way, just send me either an email, [email protected], or best way is to submit through the system, and I'll see it pop up on my screen. So Scott has some prepared remarks, and then we're going to jump right in. So Scott, take it away. Thanks for being here.

Great. Thank you, Joe, and I want to start by thanking Cowen, for having us today and letting us talk about Flowserve's sustainability program and our commitment to ESG. But before I do that, let me just give a brief overview of the company itself. And so for those that don't follow us closely, we are a global diversified manufacturer and we provide services in the flow control solutions space. And so for us, flow control, we've got components on the valve side. We do pump, which is the energy into a flow control loop or a flow loop. And then we've also got the environmental barrier, which is called a mechanical seal, which sits between a pump and valve. And so those are our major products. We sell about 50% of our businesses to new products. And then the other 50% is aftermarket and capitalizing on the installed base that we have out there. But we've got an incredibly rich history of over 200 years is our first legacy brand. We've got a suite of high-profile brands, we're on every AVL around the world. When we think about our end markets, it's oil and gas, mostly in the refining side. We've got chemicals as well, and that's anywhere from petrochem all the way to specialty chemicals. We do power, we do water. We've got general industries, which would be food and beverage and pharmaceuticals and other things. And so we've got a very big breadth of offering in terms of what we can do within flow control. And then we've also got a huge footprint around the globe. And so today, we operate in over 50 countries. And so anywhere there's a flow control challenge. We probably experienced it somewhere in the world or over time. And we're typically able to support our customers in that endeavor. And then the last thing I'd say just about the overview on Flowserve is, I've been here for 4 years now. About 3 years ago, we've launched what we call the Flowserve 2.0 transformation effort. And so we've really been on a journey to transform our business and make it just a more sustainable, more profitable, more value-creating entity. And I'd just like to share, we've made incredible progress on that. All of our internal metrics are pointing in the right direction. And so when we think about our people, it's employee engagement, it's our safety metrics, are all doing good things. Our operational metrics have improved dramatically. Last year, obviously, with COVID, in which we went down and the markets went down. But our internal metrics on decrementals, ROIC and all that are better than we've seen in a long time in the company. And so the transformation is working, and we're very excited to start to see our markets come back and start to see our bookings inflect. And I'm confident that through the transformation and what we're doing, we're going to be in a really good place. And then, Joe, let me just say a few words on our journey on sustainability, and then we can jump in to the questions here. And so like most companies, we are on a journey on this to be a better steward of the resources and improve our position as a global corporate partner within the communities where we live and work. And I fundamentally believe that the progress we are making to support our stakeholders, which would be our customers, our employees and our communities is directly related to our ability to deliver value. And so if we can do things well on the sustainability side and the ESG side, then we can do the things to support our customers and create value for shareholders. And we've made significant progress. So much like the Flowserve 2.0 transformation, we've made great progress on sustainability and ESG over the past couple of years. And we're committed to continuing this journey. And so we'll go through this in the Q&A. I know Joe is going to hit on all of the topics. But again, I'm happy to be here today and discuss this, and it is important. And our -- just to close on the opener is our purpose statement is to make the better -- the world a better place. And so we're committed to the sustainability of the ESG side in doing that.

Perfect. Thanks, Scott. Now I've asked everyone who's been on this initial question of how do you define sustainability internally? It's a topic that everyone you talk to has somewhat of a different definition, both on the company side and the investment side. And particularly given your company, right? I mean, you have big exposure to energy markets, chemical markets, probably not the first name that comes to mind when you think about sustainability, but when you dig in, obviously, it makes a lot of sense. But curious how you define it and how you think you fit into that landscape?

Sure. So let's just start with our end markets, right? So we're about 50% in kind of oil and gas and chemicals. And you're right, you typically don't think of companies that support that as a sustainable company. But again, we're in full flow control solutions, right? And so what we're trying to do is provide pumps, valves and seals to make those operations even better. And so we'll get through kind of things that we're doing in energy transition or how do we reduce their carbon footprint. But these are all things that we're positioned incredibly well to support our customers on. And so we believe that if we can help our customers on this journey, then we're a significant player through the sustainability efforts. And then the other side of that is, if we think about our other markets, right? We participate in water, we participate in pharmaceuticals. We did a press release here recently with Pfizer, where we have a long-term service agreement where we're providing the mechanical seals in their barrier, in their vaccine development and in the vaccine production. And so we can touch so many different industries that can be really broad here. And then to answer your question, how I think about sustainability is really in a broader context. And to me, corporate sustainability is about making the world a better place through our actions, our decisions and our processes in the company. So it ties nicely to the purpose statement at Flowserve. And again, we're absolutely committed to doing this. And so creating a positive impact on the globe through the Flowserve Corporation is kind of how we think about sustainability. And we've got a sustainability report that we publish every year. We kicked one out in Q3 of last year. And the 3 pillars we used to look at this are people, planet and operational excellence. And so on the people side, we've got 16,000 associates around the globe. And when we think about sustainability for us, it's creating opportunities to develop and grow our workforce in a safe and productive environment. So our safety program is essential, being productive in providing opportunities to focus in various countries around the world is incredibly important. And then we also have something called Flowserve Cares, where we're giving back to the communities where our associates live and work. And that's an important part of our sustainability program. And then on the planet side, it's about reducing our environmental impact or footprint in helping our customers improve their energy efficiency and carbon reduction as well. And so we can get into more of the stuff that we're doing around the planet, but that's a big part of the sustainability program. And then finally, for us, it's operational excellence, and that's how we run our company. And when we think about operational excellence, it's built on our Lean 6 Sigma foundation and values. And that's all about eliminating waste in our operations. And so that waste it could be scrapped, it could be excess labor but it's driving down those things and getting them out of the system and making sure that it's systemic change to eliminate waste in everything that we do. And so that's why the operational excellence is such an important pillar for our sustainability program.

Scott, you said you've been here 4 years now in the role. So you've seen a lot in 4 years, just probably putting it pretty mildly.

4 years, and it feels like 10.

I mean so when I think about sustainability as a new focus area, right, you're going through Flowserve 2.0, you dealt with an energy crisis, negative oil prices, a global pandemic. Like how do you determine what's the appropriate amount of time to spend on something given other high priority kind of organizational focus is going on at the same time?

Yes. To be -- it always goes back to our purpose and values, right? And so our purpose is extraordinary flow control solutions to make the world a better place. And then the #1 value in our organization is people. And so we've got that as a first value. And so I think if we can stay as a purpose-driven organization and we continue to put our values in the forefront, then sustainability is relatively easy. And then the other thing is, as we're looking at our strategy and we say, well, where is Flowserve today? And how do we participate in the future, that's where the energy transition comes in. And so we know that the markets that we're serving, the bigger markets in refining and petrochemicals, we know they're under pressure, operators have to change. This is in the news, in the press very recent here with Exxon and Shell, but it's out there all the time. And so we believe that through energy transition, we can help operators today, and we can help them through this transition. And so I think sustainability and ESG tie nicely to our purpose. It ties nicely to our core values. And it fits in our strategy. And if you can get that confluence of value strategy and purpose, then it becomes really easy for us.

And yes, in that way, did some of these things build on each other strategically too? I mean, I know when -- prior to your time at Flowserve in a different world for energy Flowserve was a fairly by design, widespread organization with lots of facilities in kind of weird areas because that's where it needed to be with project everywhere. And as you've kind of streamlined the company, does that in a sense, kind of feed on an internal efficiency on the footprint side of your business kind of drive -- help drive sustainability targets internally as well?

Yes, sure. So we've committed to 40% carbon reduction internally and I'll talk about what we can do externally, but that's what we've set right now, and we've committed to a relatively short time line to do that in 2030. And so in 10 years, we need to get 40% of our reduction -- our carbon emissions reduction down. Where we get that from is consolidation of roofline. It's doing things differently on the power source and the energy that we're bringing into our operations, it's being smarter about our vehicles and service trucks and things like that. But I'd say the #1 driver there is just really leveraging the existing footprint that we have. And making -- going back to operational excellence, if we do those things properly, we expand capacity within the facilities that we have, and we're able to reduce our footprint. And so even before I got here, we were on a realignment journey where we took out a lot of roofline and substantially simplified our footprint. And we've continued to do that since I've been here. And so last year, we took out about 5 different facilities around the world, and we'll continue to do that over the coming years as well.

Can you talk a little bit about the Lean 6 Sigma and how that has become more ingrained into the organization and what that's doing? And maybe if there's any sort of like reference numbers? Or how is that incentivized within the organization to kind of hit new targets that maybe didn't exist years ago?

Yes. Sure. So lean is super import of what we're trying to do. And so again, lean is about eliminating waste and continuous improvement, and that's the mentality we want in not only in our manufacturing and our operations, but also in our services. And so when we think about the manufacturing side, we can eliminate waste with less roofline, we can eliminate waste by being better on scrap and quality, and then also less energy involved in making and delivering our products. If we -- all of those things will contribute to our carbon footprint and the reduction there. And so back to kind of the organization and what we're doing is we've now stood up what we call our continuous improvement organization. They're all trained on the Lean 6 Sigma philosophies and principles. We've got a lean team that's got goals and metrics, and we do Kaizen Events on a regular basis. And so now any time we go to an operational review, one of the aspects of that is going through the Lean 6 Sigma program, where we're at? What we're trying to accomplish? What are our goals? And how do we do that? And so I think the organization has made tremendous progress in this. I think Lean 6 Sigma before was really a cost reduction tool, and we are doing more of the 6 Sigma than the lean and now we're very focused on lean. And the benefits of that are just huge. And so waste reduction is one, but when you think about customer experience and supporting our customers, it really is significant. And so I feel really good where the program is at. I feel good with our leadership. And again, now that I'm getting out, I'm starting to travel again, really starting to see the results of the lean program that we put in place about 2 years ago.

So it's got to be challenging from an internal standpoint, just given the nature of your business and where you operate in some cases, it's like trying to be as local as possible. How do you ensure that the supply chain is sustainable in meeting the requirements that you have internally when you're operating in places that don't have -- in many cases, don't have the same requirements or focus as you would have as a company here?

Sure. And again, we operate in 50 countries around the world, and we're chasing low-cost products like our customers and others. And so it is a challenge on the supply chain. And what I would say is part of our transformation was really about formalizing our strategic partners on the supply chain. And so really, a lot of the Flowserve issues were just related to incredible decentralization, a lot of local decisions and not a whole lot of leveraging the scale that we actually had. And so part of the supply chain initiatives was really going from this reactive supply chain management to a programmatic approach. And so having preferred suppliers that we can go and audit. And when we do an audit on a supplier, it's not just about the product or the product quality, we'll audit their safety program. We'll audit there -- we'll do the full audit and sustainability aspects of that audit are really important to becoming a partner of Flowserve. And so I don't know exactly what -- where we've gone from reactive spend to proactive spend, I don't have that number. But I would say it's somewhere of the magnitude of like we had 10% under-managed contract, and now we're at like 60% or 70%. And so we've made significant progress here. And again, we want these companies to be our partners, right? We're relying on them to meet our customer expectations. And so as a partner, we have expectations for them. And we believe, just like with our operations, right? If they're safe, if they're doing the right things in the community, if they're treating people properly, if they're doing what's right in the environment, then they're going to have a better run facility. And so we certainly hold them to the standards and the expectations that we have for our own facilities.

So when you have discussions like this, everyone says, the right thing all the time. And then do you see it translating into like business decisions from customers? Like at the end of the day, if you're bidding, is it like do your customers care that you're going through all this? Or is it, well, these guys are a little bit cheaper at the end of the day. So screw it, we're going to go that route? Like do you -- are you getting the perceived value that you're driving internally at the end of the day?

That's a great question, Joe. And I would say there are -- today, there are very few times when this matters to our customers. What I would say, though, is I think that is changing. And where it changes is just like on the supply chain, right? We have customers that we have strategic partners with. And I won't go through names, who's doing well and who's not. But we have a handful of top customers in the chemical space, refining space, even in the water space, that they value these things. And they believe, like me, that doing things around sustainability, doing things around ESG, treating people fairly and responsibly are things that matter and will ultimately lead to better business practices. And so I do think the dialogue is changing. I don't think we've gained market share by our efforts and what we're doing. And then I'd just say, when we get into an incredibly competitive environment through an EPC where we're bidding a large project, it doesn't matter at all. Like it doesn't show up. But again, I do think the world is changing. And I think with some of the operators where we do have strategic alliance, like we talk about these things. We talk about safety for the first 5 minutes of the meeting. We do a values moment in the meeting where we talk about our values. And then where the other part is changing, especially like on the refineries, in the petrochemical side is, they're under incredible pressure, not only on the cost side, but to reduce their carbon emissions and to just show that they're doing something that's supporting the environment. And so now with our energy transition strategy and approach, we're partnering with them to drive their energy consumption down. We're partnering with them on carbon emissions reduction. And we're now providing a value-added service that they're desperate to latch on to. And so we really are starting to have some very different discussions. I would say all of this is relatively new, so call it, like in the last 12 months. But I'm confident that the world continues to make progress here. And I think we will be differentiated with our customers at some point in time.

Yes. I mean it's an interesting kind of like chicken or the egg thing. I mean the commitment to ESG can serve to like increase investment dollars into a company's stock, but then those same people were going to want to see translate to economics. And if the customers don't care, then it's like -- it creates destruction, but obviously what you expect -- but what you're seeing with Exxon and some of these things maybe will -- maybe that does change the paradigm a bit there. Just maybe kind of building on that. Internally, how does an ESG aspect or a sustainability aspect to like a particular initiative or project kind of tie into when you think about ROI? And if you have a finite dollars of spending that you're going to do in a particular year and you have too many things that -- more things that you'd like to do than you can do, how are you evaluating like a soft element of it that might be a sustainability piece?

Sure. Yes. So I'd just say how we're organized with ESG. We have 1 person that's kind of our champion of ESG, it's our General Counsel. And then we've got people that own the different pillars and our actions and initiatives. And what's interesting is, as I think back to kind of how we established this about a year ago and some of the things that we're doing this year, we really haven't had to evaluate or make really hard decisions on a return basis and say, "Hey, if we do this, we're going to trade-off on that." That just hasn't ever come up yet. And so I do think there'll be a point where that will happen, and we'll have to make some decisions that might be on the -- might not quite be there on the return basis that we want. But just to be in, I haven't seen that yet. And really, probably the bigger concern for us is just resources and making sure that we're not overloading our workforce with different initiatives and things like that. And so what we've said is we've been very careful to say, we've got a limited number of enterprise priorities and enterprise initiatives. And ESG is on the list. So it's in our top 10. And so by just putting it in top 10 and publishing it, everybody knows that if we do -- if we say we're going to do something on ESG, like it's going to get done. And there's no excuses or no exceptions to not getting it done. And so I think just, again, being very clear from the top -- from me saying that this is important to us. It's important for our long-term success, then we're getting the resources, the focus and the attention that we need to make the progress. But it is an interesting question on the ROI and kind of how does that stack up without the alternatives. We just haven't really done that, and we haven't needed to. But I think we'll continue to make progress there. We are spending money on the program, but we haven't -- hasn't gotten the dollars that are big enough that we need to stack that up against some of the other investments or making those difficult trade-offs.

Yes. I mean, I think the other interesting paradox with like what you guys do is, I guess, the most sustainable thing is to have products that don't break and don't need to be replaced and serviced, but that's the best part of the business. So as you think about something like RedRaven, when you go down that route, where you're going into like monitoring, preventative maintenance and things like that, how does -- how do you think about like the economic impact that, that might have to like an aftermarket focused in business to maybe a new way of doing things?

Yes. So again, it's -- this is where sustainability fits nicely with our strategy, right? And so we know that we want -- we've got to digitally instrument our equipment. And we know that, that information, that data will make us a better provider of flow control solutions. And so by instrumenting pumps, by instrumenting valves and mechanical seal systems, we now can get information on flow loops. And the information is incredibly broad, right? It's around uptime. We can do predictive analytics on -- in just predicting failures on the pumps and the other part of it. We can measure energy consumption. We can tell how much waste is coming out of the system and leaking on the mechanical seals. And so now we've got an infrastructure and a system that can provide operators inedible information that they didn't have before. And so it kind of fits incredibly nicely with our strategy and our approach. And so back to some of the strategic partners that we have with our customers, we'll sit down and we talk to them about the RedRaven and instrumenting a suite of equipment that we have at their facility. You can't sell that at the maintenance manager level or at the operations level at the plant, you've got to sell it at very high within the organization. But when we lay it out and say, "Hey, we can give you an energy advantage, we can reduce your leakage rates and your emissions, and we can give you prediction on reliability." It's a no-brainer. So they're incredibly excited. And so for me, what's really exciting about this is we can do some things with our own footprint, and we're absolutely committed to doing that, right? We've stated this 40% reduction in carbon intensity. But if we can do some of the things that we believe are capable at big refineries, petrochemical plants, a big water desalination plant or any of these big infrastructure products, we can save significant amounts of energies that are -- it dwarfs what we do internally at Flowserve. And then you start to put the carbon sequestration and carbon capture equipment on there, and you're talking about magnitudes of carbon and CO2 reduction that we don't even -- it's 10x what we produce on an annual basis at 1 site and on 1 flare stack. So I really believe that through IoT, through RedRave and through our offering around energy transition, our handprint on sustainability, certainly on the environmental side, is massive, and we're really only at the beginning. And so some of the discussions that we're having with big customers are gaining a lot of traction. We've got a lot of installed base happening, but they're not quite at the point to roll this out into a full-fledged offering. We want to pilot kind of 1 or 2 more locations. But as we do that, we'll start to be more and more public about what we're doing. And then just this reliability of the unplanned downtime, it's massive, right? And so it just causes so much problem in the system of any of these big process facilities and it consumes a lot of energy, actually kilowatts, plus you've got the leakage impact of it as well. And so if we can help operators do that, it's a win-win for both of us. And just finally, where we capitalize on it is what we're trying to do is move to more performance-based contracts. And so if we're instrumenting and we're collecting data, then what we'd like to do is be able to kind of create baselines, and you can create a baseline on the energy consumption, create a baseline on reliability and uptime. And then as we exceed those targets and metrics, then we share in the upside that we're prepared to commit to. And so we're starting to have those discussions as well, and we're having some success. But again, it's -- you're selling at the highest levels of the organization, not necessarily down with the maintenance manager or reliability engineer.

And along those lines, I mean, this might be a bit we'll find out over the next couple of years because like this big sustainability push happened at a time when a big project kind of world is weaker. But are you -- at the engineering stage of some of these larger projects that your customers might be thinking about, are they having, like -- is there a sustainability person kind of like much more indoctrinated into that? Kind of engineering process, where like it kind of informs how you need to be? Or maybe they -- that person might be able to say, all right, well, Flowserve, given what they're doing, they're kind of on the same page with savings and energy. Like is that is that factored into the really early stage parts of these projects now?

Yes. So it's really -- it's the same answer that I provided on do customers care about this. And so where we have strategic relationships, and we can tell them, hey, we can design out carbon if you help us and let us in on the design aspects of this, like we can create a more energy-efficient flow. And we can do it by using RedRaven. We can do it by using the knowledge and know-how that we have. When we get invited to that, I'm 100% convinced that we can provide a significant advantage. And again, we get that access with our strategic partners, but in a -- let's just say, if it's an EPC project out of Mexico, we're not getting the opportunity to have that discussion. It is all on price.

Yes. We have a couple of questions here on like carbon capture from the audience. So what are you guys supplying into that market, like from a product standpoint? And how big is that for you guys currently? And like what do you think is a realistic kind of level that can be at as this becomes more of a focus?

Sure. Yes. So we relaunched a product last year as the SIHI liquid ring compressor. And so that's the product that we use in carbon capture. And so essentially, we're doing this on flare gas recovery, primarily in refining and petrochemicals. And so we're capturing the carbon in the flare and we're reinjecting back into their process. And so we've got a long list of examples here. We're partnered with one of the major operators on the refining space. And right now, the demand is exceeding our ability to produce this product. And so we're ramping up our capacity as fast as we can. But I envision that this is worth at least a couple of hundred million dollars on an annual basis for us. We've got to do some things to bolster our engineering and our support. And so it's a fabricated skid. It's not just selling a compressor. And so we've got to get a little bit better about fabricating the module to help their processes. But what we're trying to do is get this modularized, we're trying to understand better kind of how broad of flare gas and flue gas recovery systems can we apply this to. But right now, we've got a sweet spot that works on petrochem and in refinery and flaring. And so again, it's -- where we have the strategic partners, we're doing really well with this. And right now, we can't keep up. And so we're going to continue to expand our capacity. We'll expand our engineering, our ability to engineer and fabricate these skids. But I'm pretty excited about the overall potential on this.

You guys also play in the water sector, is that -- maybe speak for a minute about where you are in that world. And is that another area where you can -- I mean, there's a big focus on biogas and capture there? Is that an area that maybe you're not playing in now, but as an adjacency that you can either look at either organically or through an acquisition?

Sure. So we've always been in water, right? It's not a huge part of our business, but it is growing and it's something that strategically we want to be more and more involved in, in the long term. And so for us, it's more on the kind of engineered water. And so I think flood control, desalination, wastewater, kind of big water projects. And so you see a lot of these in the Middle East. You see a lot of it in India. You see some in the United States, more in the flood control side. But it's an area where we're revamping our product line. We've put a lot of effort in this over the last 2 or 3 years. And I'm confident that we're going to grow this. And so we'll see growth this year in 2021 in our water offering. And I think that continues to grow as we go forward. And so I think over the long run, right, we want to continue to diversify, right? We want to be more in general industries. We want to be in more water and so we'll keep doing that. And then just on the bio side, anytime they're doing a new facility. And so let's just say they're taking an old refinery and making it into a biodiesel plant or some sort of biorefinery. We've got the opportunity to go in and retrofit the pumps and the valves and the mechanical seals to fit their new systems and process. And when we do that, we've got a great opportunity to say, hey, guys, well, look, while you're doing bio, why don't we talk about carbon capture and carbon sequestration? And why don't we talk about energy efficiency? Because then you can go to the market with kind of a 3 win, right? You can go and talk about your bio degradable or your bio fuels and what you're doing there. You can talk about the carbon footprint reduction. And you can talk about energy efficiency. And so we're having some successful conversations with that already.

So I think we have some few seconds left. I did have one question that I wanted -- that I missed earlier but I wanted to ask like you're kind of in -- we're at an interesting point with this push towards energy transition, but you are a major supplier to companies that are going to transition themselves but have existing footprint for like the foreseeable future that are going to be operating. So how do you kind of in a way internally, your commitment to these customers long-term for their existing facilities? Plus we need to have innovation in refining and possibly need innovation and solar and things like that. So how do you kind of -- how do you allocate appropriately to serve these customers through a transition?

It is absolutely a management challenge. I will say that for sure. But we are committed to our existing customers, right? And so we've been working with customers for 200 years, and we're not just going to walk away and go do something else. And so kind of what we say is we're committed to our customers today and through the energy transition. And we also believe that there's opportunity for us. And so if you look at the spending that's going to be there on carbon capture, the spending that's going to be there around energy efficiency, we think that there's enough there that we grow our business for decades to come. And so we're a 100% committed to supporting the customers today. And we believe that, that helps us in the long term. Now in the background, we're going to continue to look at water. We're going to continue to look at other growing and niche markets and making sure that we've got the flow control technology to support that and make sure that we do have a diversified portfolio. But I would say we've got a lot of different growth numbers and kind of what the market size looks like and the investments that are going to go into the energy of the future. And we're confident that all of those require flow control solutions, and that will be a relevant player regardless of how fast that energy transition goes or if it goes slower. And my belief is it's going to take a lot of time to do this. And through that process, big operators are going to spend a lot of money to drive their energy usage down. They're going to spend a lot of money on their carbon footprint. And all of that is opportunity for Flowserve.

Perfect. I think we've got to leave it there. We're a couple of minutes long. But Scott, I appreciate the time, and thank you, everyone, for listening. We'll see you soon.

Thank you, Joe. Appreciate you having me today, and thank you, everyone, that joined us today.