Flowserve Corp at Stifel Cross Sector Insight Conference Transcript

The following is excerpted from the question-and-answer section of the transcript.

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Yes. And for most of the people who have been in here today know I'm going to present 3 bear cases on Flowserve stock. Scott's going to tell me why I'm an idiot for presenting those 3. And then I'm going to present 3 bull cases, and Scott is going to tell me why I'm a genius for presenting those 3. So we'll jump straight into those. So first bear case, EBITDA margins have been in decline since -- the last peak in oil price in 2014. And despite multiple rounds of restructuring, much of which happened before you arrived, and the Flowserve 2.0 transformation, 2022 margins were the lowest in 25 years. The 15% to 17% operating margin targets that were outlined in 2018 are not credible, and it's difficult for investors to have confidence in sustainable margin expansion.

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : So -- I mean, '22 was obviously a very challenging year. A lot of that, I think, had to do with supply chain and frankly just costs...

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : A lot of that has kind of resolved itself. Is there any way to quantify kind of what it cost you last year? I mean, containers were 6x the pricing that they were in '21, if you could find one. I know you guys will put your pumps on planes and...

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Is there any way to quantify or qualitatively talk about the impact that, that had on margins this year and kind of the, I don't have to do anything to get that back in '23, right? Those kinds of costs have just gone away. Containers are back down -- gone to where they were in '21 and pre-COVID. A lot of those costs have kind of worked themselves out of the system? REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. JUNE 07, 2023 / 7:35PM, FLS.N - Flowserve Corp at Stifel Cross Sector Insight Conference

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Well, I'm just going to go over to here, seeing as we're talking about it already because it sounds like this bear case might actually be a bull case. Historically, during cyclical CapEx upturns, which Flowserve is starting to see now, there's too much capacity chasing OEM project volume and pricing has been very challenging, leading to lower incremental margins as backlog turns into revenue. It sounds like from what you're saying that that's already happened, and we're starting to come out of the other side of that, which is what I have questions on here about. So with the commentary that you just made that some of that lower-priced backlog that you took in 2020 and 2021 is now working its way out, maybe you can just talk about the pricing that's coming out of backlog today versus what was coming out yesterday. And the price of -- pricing on what's going into backlog today versus what was going?

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : So the pricing on these large OEM projects is less set by the customer and mostly set by you all and your competitors, right? Because you're talking about projects where -- for -- to simplify it, you write a number on an envelope and the customers go and open all the envelopes and lowest price sometimes, right? Well, then they give you some feedback. And so the pricing is set by what margin you are bidding on that work and what margin you can bid at is set by how low your competitors are prepared to go. So as you fill that capacity up, everybody starts writing higher numbers on those envelopes and that's how the pricing improves. So this is not really dictated to you by the customer. It's dictated by how full backlogs are and how rational the competitors are.

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : And you talked about on putting a 5% price increase through. So that's -- we're less talking about the large OEM project bids there. We're talking about more bids...

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Yes, (inaudible) pumps, valves that are going through distribution after market. How have you -- how has the traction been with that 5% price increase? Are you getting through what you expected to get through? Markets accepting that kind of price increase given the growth in the market, just a little bit commentary on it?

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : And your distributors are kind of your best friend when it comes to that, right?

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Putting a gross margin mark up on it. As long as they can pass it along, they're happy to have...

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Okay. I'll jump on to the next bear one. Growth in energy transition and other markets won't be enough to offset the secular decline in oil and gas markets and Flowserve is likely to grow slower than GDP as a result?

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Yes, we've definitely seen in the short term, there's no problems with the energy markets, which is good. So I'm going to jump forward here onto the bull cases. Thanks for entertaining my bear cases. Flowserve has several positive demand drivers over the short, medium and long term with high commodity prices and underinvestment during COVID, renewed focus on energy independence, driving investment in oil and gas, LNG, nuclear, and decarbonization spending, driving investment in energy efficiency, biogas, carbon capture, utilization and storage and hydrogen. So there are a number of positive demand drivers here. And even I think on the oil and gas side, in the short term investment there is good. We are under investment for a decade and people are catching up. So maybe you can talk about these opportunities, how meaningful they are to Flowserve and what the outlook is for these various markets?

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Very early innings in a lot of these things that will last for a long time.

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : And there are a lot of these large projects out there that would order Flowserve equipment later on in the project planning. So there's a lot of projects out there that haven't got to the point yet where they would be ordering stuff from you. So you're likely to see some of the large LNG plants that are under planning or opportunities for Flowserve, that are -- those projects are there, they're going to get completed, but they haven't got to you yet. REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. JUNE 07, 2023 / 7:35PM, FLS.N - Flowserve Corp at Stifel Cross Sector Insight Conference

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Okay. The next one is on the 3D strategy. I think we've probably diverse (inaudible) decarb, so then we'll talk about digitization here. And you've outlined it, so I don't need to read through this. But I guess the piece that we probably haven't touched on while we're talking today is the digitization piece. So maybe if you could talk about the opportunity for digitization, how that benefits your customers, how that benefits Flowserve, how that benefits the shareholders?

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : It would seem to me that digital on flow assets, particularly on pumps, would be something that customers would be looking to adopt. I mean, the cost of failure is very high. The loss of productivity as those things wear is fairly high. What do you credit the -- I mean, the slower than -- you said very frustrated, and it's not slower, not faster uptake. I mean, I would have thought that, that would be something that customers would be pretty keen to get on. What is it that you credit the slow adoption rate to?

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Okay. Let's jump into the last one. Cash generation had improved significantly in recent years with 95% conversion over the 4 years, '18 to '21, having averaged 66% for the prior decade. I'll leave out '22 because I think that's...

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Improvements in working capital are structural and sustainable, and Flowserve should be able to maintain this improved free cash flow conversion going forward after the disruption in 2022 that's related to COVID, enabling capital deployment opportunities that have been absent the last few years?

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : You've got a good backlog, margins going up. So you've got EBITDA increasing. You've got cash coming in. So you've got the debt decreasing, which is getting you into a position where leverage is going to be at a spot where you can deploy more capital. Maybe you can talk about Velan a little bit. And then what the strategic priorities are for capital deployment? REFINITIV STREETEVENTS | www.refinitiv.com | Contact Us consent of Refinitiv. 'Refinitiv' and the Refinitiv logo are registered trademarks of Refinitiv and its affiliated companies. JUNE 07, 2023 / 7:35PM, FLS.N - Flowserve Corp at Stifel Cross Sector Insight Conference

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : It's been a while.

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Awesome. Well, we are up on time. So thanks everybody who joined us this afternoon, and thanks, Scott, for being here. Appreciate it.

Question: Nathan Hardie Jones - Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst : Thank you.