Flowserve Corporation (FLS) Earnings Call Transcript & Summary

Hi, everybody. Mike Halloran with Baird here. Thanks for joining the Flowserve session on stage with me is Scott Rowe. We got a couple of people hanging out in the audience as well, including Amy and Olivia. So we're going to do a pretty normal session here. Scott is going to lead in with some prepared remarks. We're going to follow up with a fireside chat Q&A session. If you've got anything that you want to talk to, please e-mail me, raise your hand, and we'll make sure we address it. There should be cards in front of you for the e-mail side of things. And the hand raised, I'll just try to be observant. So with that, Scott, please, the floor is yours. Thanks for coming.

Yes. Good afternoon, everyone. Thanks for being here in person. And for those that are listening online, thank you for your participation. Mike, thanks for having us. This conference is one of the best industrial conferences every year, and so we're excited to be a part of this. So just kind of overview on Flowserve and some general concepts, and then Mike's got a long list of questions that we can go through, and we'll answer any from the audience as well. Obviously, we just finished our Q3 call, really strong results. We had very healthy bookings at kind of $1.2 billion. We had continued margin expansion. And so I'll kind of walk through why we believe that we can continue that margin expansion. And then we delivered $0.90 of EPS. And so it was a really good number for us and a good print. And if we go back to kind of what's happening in the business, maybe 2 things. We've got a strategy, which is our 3D strategy of diversify, decarbonize and digitize. That strategy has been in place now for several years. We continue to see our business further diversify away from upstream oil and gas and so that is working. When we look at the bookings for the quarter, less than 10% were large projects, which are typically that upstream oil and gas. And so we're seeing more aftermarket, more diverse end markets, and so the business is more resilient than ever before. On the decarbonization side, I'll come on nuclear, but you've got nuclear in there. We've got LNG in there as a transition, but also a little bit on carbon capture and some of the other things that are in decarbonization. And so we're still really excited about that lane. And then on the digitized side, ultimately, what we want to do is be able to support our customers with our pump and valve technology through instrumentation, through a digital overlay allowing them to monitor, allowing them to prevent unplanned downtime through our prediction algorithms and then ultimately helping them with flow loop uptime and optimization. And so we're excited about that offering. We can get into it if we need to. And then secondly, I want to talk about the Flowserve business system. And so we have a slide in the Q3 deck, but we're excited about what the business system is doing. For those that have followed us for a long time, I've been the CEO now for over 8 years, it has been a journey. And when I got here, we were not a process-focused organization whatsoever that was -- we were furthest from that, as you could ever imagine. And today, we use the business system to really drive and run our business. It's how we do our work. And so we've got 5 verticals there. We have people excellence, operational excellence, portfolio excellence, commercial excellence and then innovation excellence piece of it as well. And we take all of those pillars seriously, but I'll just touch on 2 because it's really what's driving our margin expansion. So operational excellence is very serious. It's a commitment to, what I'll call, lean principles, basics of manufacturing. So I think shop floor daily management, how do you solve problems at the lowest level within your organization? How do we think about inventory management? How do we do material flow like all of those good things. And we have seen tremendous results in all of our operations, and that has been driving a big part of the margin expansion. And then secondly is portfolio excellence. And within portfolio excellence is 80/20. We have fully committed to 80/20. We are in our second year. We put some metrics in our slides in Q3. So our first business unit, industrial pumps that has gone through this is seeing tremendous results. And so year-to-date, that business unit is up 150 basis points of margin. We've reduced 45% of all of the SKUs in offering and so massive complexity reduction with that overall offering in our target selling. And so this is a framework where we say we want to support our best customers, and we call them out by name. Our target selling efforts have generated 21% growth within the business. And then we've also divested a piece of that business that's no longer core to what we're trying to do. And so my point in saying all of that is 80/20 is alive and well. We are fully on the methodology, and we're making great progress. And so we're very excited about that. And then the last leg I'll touch on is our commercial excellence. And so with 80/20 comes a little bit of downward pressure on your revenue as we're eliminating 45% of all of your SKUs. With that said, net-net, we've done a nice job continuing to grow the business. But we needed to lean in on commercial and really drive growth. And so the commercial excellence is all about that, and we're excited about what we can do. And then lastly, in Q3, we talked about what we believe is our entitlement with the nuclear end market. And so we put 3 slides together that basically describe how Flowserve is positioned historically, but then also what we think our right to win is. And I won't go through details, Mike, I'll let you -- you ask me questions on this, but essentially, we committed to or we put a number out there of a $10 billion bookings surprise over the next 10 years. And we believe that's possible because we have strong domain expertise. We're in reactors all over the world. In fact, we have equipment in 75% of all reactors. And it is a very exciting time in the industry, and we're one of the leaders within flow control for the nuclear space. So at that, Mike, we'll open it up.

Why don't just stay on the nuclear piece, it is a question we're getting a lot on. So let's just start high level and frame the entitlement to win. You referenced the 75% installed base. There's a lot of barriers for other people trying to compete to that. So maybe talk about what that looks like and then also talk about what you play in and what the revenue opportunity can look like as refurbs and recycles.

Absolutely. So we see nuclear prize in 3 categories. One is the traditional power in the new build of that. Second would be your SMR technology. And then third is the aftermarket. And so the aftermarket, we have our normal aftermarket run rate. We've got life extensions in there. You've got kind of a resurrection of facilities that have been shut down and now they're restarting. And so we include that in there as well. And so back to barriers to entries and right to win. We participated in all of the different customers around the world. I would say the 75% includes China nuclear, and the future of China nuclear does not include Western companies. And so as we think forward, we will still get aftermarket and support those existing reactors. But we won't be part of new build programs in there. With that said, there's still a massive prize. And what we put in our numbers is roughly 40 new reactors being built over the next 10 years. And we believe those are with people that we have strong relationships, preferred technology. So these are all the normal suspects like Westinghouse in the Americas and potentially in Europe, EDF and in France and then other parts of the world that we do really well in. And so we've got a great position. We've got product that's in there. And when you're in the nuclear industry, safety and reliability are the 2 most important things. And what these operators don't want to do is change equipment or change suppliers when they know something's working. And we've been involved in the industry for almost 50-plus years. They don't want to make decisions that could jeopardize the future safety. And when something works, they'll typically stick with it. And so we're very confident that we will be a part of the future. We're also trying to figure out how do we make sure we can grow our entitlement within nuclear, there's 2 things. There's the nuclear island and then the power island. We do participate in both. We believe in the power island, we can bring more of our products in where maybe that kind of barrier to entry is slightly lower, but they know us well across that portfolio. We believe we can actually grow our entitlement as we go forward there.

And so large installed base on the slides, you kind of laid out the revenue opportunity over $100,000 for, call it, a new Westinghouse type thing?

To a $100 million per reactor.

[indiscernible].

Per reactor.

Yes, different scales -- different scales. Over $100 million for that type of reactor, but there's still an opportunity if SMRs take off. How do you decide where and how you want to approach that market? Maybe there's a clear winner or not in your mind, but it seems like you've got exposure to a chunk of people and giving yourself optionality [indiscernible] plays out.

Absolutely. Yes. So SMR is a very dynamic landscape. There's more than 30-plus players around the world that are doing something around this technology. We've gone through a comprehensive kind of filter to get to roughly 10 that we believe will be successful as we go forward. And so we put a few names on our slide there, but we're working with about 10 people. And when we say working with them, it's really helping them think through the technology and what's needed for the concept of their design. And so we think of like there's a sodium concept. There's a molten salt concept. So ensuring that we've got a pump in a valve that can support the temperature in the medium that they're looking at to put in their process. And these are all things that we've done before. We've done sodium within our pumps and valves. We're in concentrated solar power, which is a molten salt application. And so we're in a really, really good position to be able to support that. In addition, we've got the certifications with the N-stamp in the Americas. We've got the European Commission and the certifications there. We've got certifications in Korea and other countries. And so we've got the ability to participate. And so for us, it's really been very focused on the few players that we believe will be here for the long run. And we believe we're working with the right ones, and we're confident that as the industry moves forward, that Flowserve will be a part of the SMRs.

So last one here. How do you think about what that curve can look like and what your visibility is into essentially these nuclear reactors either being built or refurbed or...

There's a lot of public data out there. And I'd suggest folks to look at the public data, we didn't give a time line. We put $10 billion out there, which is our bookings number. And I'd say this year, we'll book over $400 million of bookings within the nuclear space, we believe it only goes up, but it will be lumpy, right? These are big projects, and there's a lot of timing. And obviously, there's government approvals in the United States, they're state approvals. Then there's all kinds of other stuff on what could happen and how they finance these. And so it's really difficult to lock in on 1 scenario. But again, there's a lot of public stuff out there. We've been using that to model the 40 and the kind of the -- what we thought on the SMR side and what we think -- we said 30 and 5 years translate that to at least 60 in 10 years. We feel reasonably confident on that, but things can change here. What I would say is we are fully confident that there is growth in nuclear, like I don't see any scenario where this doesn't go forward. I think that rate or pace of growth is something that could be debated. But our $10 billion was built on what I would call a reasonable estimate that is in the fairway of what all of the public data would suggest.

I mean, you're seeing in the orders, right? I mean you talked about $400 million.

Yes, we're $400 million a year right now.

Your historical revenue base was a low single-digit number, and now we're talking 10% of your order base.

Yes, exactly.

So maybe transition to a conversation about what you're seeing more broadly. What are you seeing in the marketplace from a demand perspective, particularly around willingness of customers to move forward with the midsized or larger projects?

Yes. I'll start on projects, but I'd be remiss not to talk about our aftermarket thoughts. I'll do that second. But on the project side, it's been a challenging year, right? I mean you've got -- in the Americas, you're dealing with tariffs. In Europe, we've got not quite recession, but not the best end markets, and we've got still the price of energy in Europe is incredibly high. You've got a lot of turmoil in the Middle East going on. And so I'd just say, it's been a tough year for us in terms of project bookings in midsize, and it's hard for operators to think about a return on an investment when you don't know exactly what your cost position is because of a tariff or a reciprocating tariff and things like that. And so with that said, we've still had a very solid year in bookings. And so the project activity has been reasonably stable. Second quarter, we saw some healthy delays that impacted our project type bookings. But in Q3, it was a reasonable number. And then I think on the forward look, I don't -- I mean, look, anything can happen in the world, but I think we improved from here. I feel like there's a little bit more stability. I actually think the back half of 2026 looks pretty good. In the Goldilocks scenarios, tariffs settled down, peace in the Middle East, all these things, if that happens, and there's a lot of pent-up demand that happens across many industries in terms of growth for our equipment and our services. And so I'd say, nuclear aside, which we're really bullish on, the rest of the industries we're constructive on. And so in the U.S., we see growth from pharmaceuticals, where we're reasonably well positioned. We're seeing a lot of water projects as part of that, the infrastructure build-out. In Europe, relatively soft. The Middle East for us is an off year. We're probably one of our lowest booking levels for projects in the Middle East in about 5 years. I think just given some of the early build-out over the last 2 years and some of the dynamics there, that has come down, but I feel like the forward look is better than it was at. And then as I transition to aftermarket, I think what's important for Flowserve today is less than 10% of our bookings, call it, 8% or 9% of our bookings in Q3 were project booking. So it is -- we are less dependent on big projects than ever before in the history of Flowserve. And so a lot of our work today is on aftermarket or MRO, which would be a replacement valve or a replacement pump or supporting smaller projects and build-outs in many applications. And so we're a more cycle-resilient business than we ever have. The aftermarket business is growing at an incredible rate. We continue to do really good things. We're setting records almost every quarter in terms of what that booking profile looks like. And we're confident that we can continue to expand the aftermarket through doing the right things with our capture rate. And so that's quoting quickly, making sure that we can get parts in front of our operators when they need them, doing repair and service in a timely manner. When you do those things, you get the work with our -- typically with our customers, the OEM will always get that work. And so what we found with the focus and the execution is our capture rate continues to move up. And so I'd say that's a long answer, Mike, to your question, but I'd say, we feel reasonably constructive about the project environment, the aftermarket and the ability to keep moving bookings forward as we transition into 2026.

I mean as we transition to 2026, it feels like bookings profile suggests plus the backlog levels, which are very solid. So just next year is shaping up to be a relatively normal dynamic, somewhat in line with your long-term growth profile. Any put and takes towards that, that we should be thinking about?

Yes. So I was talking about market and bookings and maybe we'll convert that to revenue. And so as we think about our revenue, with the project bookings in the Middle East being low and kind of the engineered pump type projects being a little bit soft, there's some a little bit of downward pressure on our revenue for 2026. With that said, the rest of the business units, industrial pumps, the valves business, mechanical seals have all seen really nice bookings growth in this year. And so we're confident that we can grow revenue in 2026. It's not going to be something in the double digits or something crazy that we don't typically see. It will have some downward pressure because of the large bookings kind of that delay. But with the focus and the growth that we've seen in the rest of the building, we do -- or business, we do feel like we can continue to grow revenue in 2026. Beyond that, though, we start to see some acceleration with the bigger bookings than nuclear and all that. And so ultimately, we want to be in line with kind of that 5-year target of 5%. And the way we got to that when we put that target out was a GDP number topped off by some strategic initiatives with our 3D growth strategy that get us to 5%. And so next year, we know we've got to come out with some new targets because we've checked a lot of those that we can kind of walk through some of that as well. But certainly on the revenue side, we believe that with the markets that we're in, the focus on commercial excellence, how we're doing 80/20, we should be growing certainly higher than a GDP number. And the teams aligned to that, and we're very much focused on how we grow the business.

Maybe also talk about the resiliency of the model that's shifted. You mentioned in aftermarket, but we were talking ahead of this a little bit about how the model has shifted relative to the 2010s and how the -- what you're relying on to drive growth has shifted. So maybe talk about the components of that, that give you confidence in the stability of the growth, even if there is a little bit of mixed background that you have to manage.

For sure, yes. So if we go back into kind of 2010, 2015, even when I started in 2017, the business was more reliant on large projects. And a lot of that was because we had a heavier dependence on upstream oil and gas. And so historically, about 40% of the business was oil and gas. And so that would be your refining, your midstream in your upstream and about half and half between your up and your downstream. Today, we are very much in that category. It's roughly 33% of our business. So we've worked that down pretty substantially. And most of that, almost 90% would be in the refining space. And as everybody knows, there's not a whole lot of new refineries being built around the world. And so most of that business is aftermarket. And back to our capture rate and our ability to continue to drive capture rate up. We're confident in the stability and the ability to grow within refining aftermarket. So I'd say there's a very different dynamic from 10 years ago within the Flowserve business. So less reliance on big projects, less reliance on large upstream oil and gas projects. really converting more to aftermarket and more diverse kind of end markets. And for the first time since I've been here, General Industries is now the second category on our slide, and so it's moved up. And so we'll continue to push for that kind of more diversity within the end markets. And then again, that whole nuclear is just an accelerant for us on growth as we think forward. But I'd say we're more cycle-resilient than ever before. This is something that we have in our outcomes of the Flowserve Business System. And so it is something we've worked very hard on to reposition the portfolio to make sure that we can work through any cycle.

Yes. And it seems to me, too, that the reliability of the aftermarket or the consistency of the aftermarket should be higher.

Yes, much higher,...

Because it was far removed from the large build-out cycle of the 2005 to 2008, '09, however you want to frame it. And so that piece, you feel pretty confident in having facility and as well on top of the capture rate.

Yes. So aftermarket for us is, it's OpEx versus CapEx, right? And that OpEx is more tied to utilization rates, avoiding unplanned downtime. There's -- that's the focus there. And we don't see a scenario where operators aren't going to invest in the assets that they have. And so and again, we continue to do things to get more of our share and win that work. And so we believe that the aftermarket business is highly cycle-resilient, and we believe that we can grow it with capture rate as we go forward.

So let's switch to margins for a little bit, and we've got a handful of other things to cover. So you referenced earlier next year, we're probably going to have to manage the targets 14% to 16% is the EBIT margin target. You've said publicly that you would be disappointed if you're not at the high end or above.

Yes. We're in the range right now -- we're in the range.

You're in the range right now, exactly. And so maybe talk through a couple of things here. First, why the confidence is so high on top of being in the range already. But then secondarily, where are you in the journey as far as 80/20 implementation as far as the operational excellence curve. In other words, how much in your mind is left from a work perspective or from what you can control perspective?

Yes, for sure. We just had our teams together for the last 2 days, doing our 2026 AOP. And I'd just say, everybody is excited about the momentum that we've built. We're excited about what we've done with the business system. And I'd just say there's a lot of confidence with our general managers and our ability to keep doing this and moving that bar up. And so I'll break it down in kind of the components of the business system. So operational excellence is in place. It's working. I'm super proud of what we've done, the level of consistency and focusing on the right things from a manufacturing perspective is working. And a lot of our margin expansion in the last 3 years would be more attributed to operational excellence than anything else. That -- there's still room to go in there, and I'm going to come back to that because it ties to complexity reduction. So now we'll go to portfolio excellence in 80/20. So 80/20 was launched 2 years ago. We started it at the end of 2023, beginning 2024. And that framework and methodology is segmenting your product, segmenting your customers, chopping off the SKUs that aren't making you money or too much effort to support and then really focusing on your best customers. And so I gave some examples at the beginning with industrial pumps. What we've seen in year 2 is substantial margin improvement. We've cut off 45% of the offering. We're now redeploying resources to drive growth with our best products and our best customers, and we've seen a nice uptick in target selling. And so we believe companies that really follow this methodology for multiple years, continue to see margin expansion for -- you pick a number, 5 years. I mean, IDEX would tell you it's still working today, and they're 12 years into the journey or something like that. And so there's a lot of companies that are way down the path, and the results are typically kind of 100-ish basis points a year for multiple years. And we're in the second year, and we're seeing -- we showed the results in our BU. We're seeing that same level in terms of margin expansion. And so I don't think -- there's no -- we're not close to being done with 80/20, like we're starting to recut our data now for 2026. We'll now have all of our business units will be in their second year. We'll have one in our third year. And so I'd just say we're still in the middle of this 80/20 journey, and we believe that it can continue to provide support on our margins. And then just maybe coming back to operational excellence, when you're leaning out your facilities and then you're reducing complexity with 80/20, by definition, on both of those, you're freeing up capacity significantly. And so what this allows us to do is go back and think about our total footprint for manufacturing. It allows us to be a little bit more aggressive on roofline consolidation. And so there's still a net price in terms of continuing to move forward with our -- what that footprint looks like, getting in lower-cost countries, but also just making sure that we've got scale within our manufacturing facilities. Flowserve was a roll-up of roll-up. There's -- my point is there's still a lot of opportunity to drive footprint consolidation and meet the demand and the growth that's happening there. And so we feel very confident in our ability to continue margin expansion, and we'll do it on the back of those 2 efforts.

And the buy-in internally at this point in essentially, when you think about the implementation piece, are you seeing what you want to see from your employee base as they're trying to drive and have these conversations. The second piece is more on the product side. You referenced the 45% reduction in SKUs at the industrials within some of your industrial pumps. Are we at the point where we're through some of the SKU rationalization conversation? Or is there more to do there?

Yes. Every year, you recut your data. And so every year, there will be an opportunity. And so maybe I'll go -- I'll pick that back up, but let's go to the people and the culture because it's really, really important. And our first pillar is people excellence, it's about how do we leverage our talent, how do we do the right thing, how do we create a culture that makes sense. And our culture is we have a lot of engineers. We like to solve problems. The 80/20 program is perfect for that because it is data driven. And so the decisions are relatively easy. There's a lot of debate and things like that. But once you see the data, that adoption has been amazing. And so we started in pumps, so you saw an earlier pickup on pumps, valves is now fully in it. You saw some nice progress in Q3 with the valve margins moving forward. So I'd expect that to continue. And so we're all in on the methodology from a change management perspective, it's embedded in working. And I just don't see a scenario where we go backwards. And maybe I'll throw in, we did an acquisition called MOGAS about almost exactly a year ago. I was able to be at their site as I was going through multiple sites during the week, but we had done 3 legacy Flowserve sites, and then we went to the MOGAS site. In the way they did their presentation, the way the shop floor is organized, the way we have our data on inventory management and how we run the business was exactly the same. And so the adoption is really, really strong, and I'm excited about how we're running it and what the Flowserve business system can do for us.

So switching gears to capital and capital deployment I know Amy is particularly excited about the free cash flow piece.

We're excited that we're at a place that we can really deploy capital.

Yes, I know both of you think that the free cash flow as a percentage of net income or wherever you want to measure it, has a healthy path going forward still.

We can still go forward on that.

The chart acquisition didn't go through. You've been very public about the idea that you're not chasing anything large. Also took some time to rebuild the conversations with Chart falling through. Where do we stand on that side? What's the activity level look like? Are there any interesting things behind it? And then how do you balance that against the buyback aspirations that you've done more recently as well as the opportunity set there moving forward?

That's a long question.

You know what? We got 3 minutes, I'm trying to give you a lot of time.

I'll work through sequentially here. And so the proxies out between Baker Hughes and Chart, so this is all public information, but that deal came to us. It was a merger of equals. We saw a very strategic opportunity to do something that you don't get a chance to do. It wasn't something we were out and looking for. It came to us. We evaluated it thoughtfully with the Board, and it did check our capital allocation kind of framework in terms of fit with strategy, preservation of the balance sheet and making sure that we could really do the right things with the business. It wasn't going to be easy. It was big. There was some -- it was a little bit messy. We acknowledge all that. But at the end of the day, there is something there that we are confident that we could create a lot of value. With that said, Baker Hughes came in, they did a cash offer, the deal went somewhere else. We got $266 million as a breakup fee. And what that allowed us to do is really rethink what's important to Flowserve and how do we focus on our business. And so we saw a stock price that we believe was undervalued at the time. We deployed roughly $200 million back into share repurchase since the termination. Q3 and a little bit into Q4 is roughly $200 million. And then additionally, on capital allocation, we've had this asbestos liability for a long time. We announced this in the quarter, but we paid essentially $200 million to dispose of that liability. And so now we're free and clear of asbestos. That frees up some expenses and incremental EPS is we don't have to pay a bunch of legal bills and so that's exciting. With all of that said, we still have an incredibly healthy balance sheet, right? We're less than 1x leverage. We've got a healthy dividend. And so we've got to think through what's next for us. And I think the demonstration post Chart is that we'll be flexible and we'll do -- we'll put money to what we believe is the highest return. And so we'll continue to do that as we go forward. With that said, we play in a highly fragmented space. There are lots of pumps and valve companies that are out there. There are some that have technology that we don't have. There are areas that would like to get more of a presence in like nuclear and some of the other attractive end markets. And so we'll continue to kind of lean in on what we call programmatic M&A. With the Chart deal, our funnel -- we turned everything off and so now we're kind of repopulating what that potential M&A funnel would be. And we just feel like where the balance sheet is, our ability to generate cash, like this is a good use of cash, but we're going to be measured. We're going to do the things that -- what we believe will be the highest return. And again, we demonstrated that by buying shares in Q3 versus doing something else. So I'd just say we're excited about where Flowserve is. The business system and the operating model is working. We continue to believe that there's margin expansion. We continue to believe that we can integrate a company using the Flowserve business system as we go forward, and we're in a great position with the balance sheet to do some creative things.

Awesome. Well, Scott, really appreciate your time. Thank you.

Thank you, guys.

Management will be available upstairs in the Chestnut room for a breakout session. I got through most of the questions. I know there were 1 or 2 I didn't quite get to from the audience. So that's a great opportunity to go ask management about it. Thanks, everyone.