Flowserve Corporation 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2023; filed August 1, 2023. Flowserve manufactures engineered pumps, valves, seals, automation products and aftermarket services for global infrastructure and industrial markets. It operates through the Flowserve Pump Division (FPD) and Flow Control Division (FCD), with approximately 17,000 employees in more than 50 countries.
Financial Performance
| Metric | Q2 2023 | Q2 2022 | Six Months 2023 | Six Months 2022 |
|---|---|---|---|---|
| Sales | $1,080.4 million | $882.2 million | $2,060.7 million | $1,703.3 million |
| Gross profit | $322.8 million | $249.8 million | $619.6 million | $459.5 million |
| Gross margin | 29.9% | 28.3% | 30.1% | 27.0% |
| Operating income | $96.6 million | $60.3 million | $153.8 million | $67.7 million |
| Operating margin | 8.9% | 6.8% | 7.5% | 4.0% |
| Net earnings attributable to Flowserve | $51.2 million | $44.8 million | $78.0 million | $29.0 million |
| Diluted EPS | $0.39 | $0.34 | $0.59 | $0.22 |
- Q2 sales increased 22.5%; six-month sales increased 21.0%. Growth reflected higher aftermarket and original-equipment sales across most regions, despite approximately $4 million and $28 million of unfavorable currency effects, respectively.
- Bookings increased 6.4% in Q2 to $1.111 billion and 1.8% for the six months to $2.167 billion. Backlog was $2.843 billion at June 30, up 3.9% from December 31, 2022.
- Aftermarket sales represented approximately 52% of sales in both Q2 and the first six months, compared with approximately 53% in the comparable 2022 periods.
- Gross-margin expansion was attributed primarily to prior price increases and lower supply-chain inflation, partly offset by higher incentive compensation and realignment charges.
- Interest expense increased to $16.6 million in Q2 and $32.8 million for the six months, reflecting higher borrowing costs and the termination of cross-currency swaps in late 2022.
- Other expense was $5.5 million in Q2 and $13.6 million for the six months, primarily because of unfavorable transactional foreign-currency movements and foreign-exchange derivative losses.
Segment Results
| Segment | Q2 Sales | Q2 Operating Income | Six-Month Sales | Six-Month Operating Income |
|---|---|---|---|---|
| Flowserve Pump Division | $765.4 million | $98.0 million | $1,465.5 million | $177.1 million |
| Flow Control Division | $317.7 million | $36.1 million | $599.3 million | $54.6 million |
FPD Q2 operating margin was 12.8%, versus 9.3% in the prior-year quarter; FCD operating margin was 11.4%, versus 11.3%. FPD’s Q2 gross margin declined modestly because of compensation, realignment charges and mix, while FCD benefited from favorable original-equipment mix and pricing.
Cash Flow, Liquidity and Debt
- Six-month operating cash flow was $50.4 million, compared with cash used of $71.4 million in the prior-year period. Inventory increases used $99.2 million of cash.
- Capital expenditures were $31.9 million; management estimates full-year 2023 capital expenditures of $75 million to $85 million before acquisitions.
- Cash and cash equivalents were $422.8 million at June 30, compared with $435.0 million at December 31, 2022.
- Total debt and finance lease obligations were $1.301 billion, including $495.2 million of 3.50% senior notes due 2030, $494.6 million of 2.80% senior notes due 2032, $239.6 million under the term loan and $50.0 million under the revolving facility.
- The company had $553.8 million of borrowing capacity under its senior credit facility at June 30 and was in compliance with all applicable covenants. Revolver borrowings increased to $90 million as of August 1, 2023.
- Term-loan repayments of approximately $20 million are scheduled in the remainder of 2023 and approximately $60 million in 2024.
- Dividends paid during the first six months were $52.5 million; dividends declared were $0.40 per share. No company share repurchases occurred, and $96.1 million remained available under the repurchase authorization.
Material Changes and Unusual Items
- The 2023 Realignment Program produced $28.4 million of charges in the first six months, including $11.6 million in Q2. Management expects approximately $40 million of total investment for identified and initiated activities, including $13 million of estimated non-cash costs.
- Management reported approximately $3 million of cost savings during the first six months and expects approximately $16 million of annualized savings in 2024 after identified initiatives are completed.
- Results benefited from the absence of $20.2 million of Russia-related pre-tax charges recorded in the first quarter of 2022. Flowserve has ceased operations in Russia and reported that existing reserves remained sufficient at June 30, 2023.
- Flowserve agreed to acquire Velan Inc. for approximately $245 million in cash. Regulatory approvals were substantially obtained, but French Foreign Investment Screening approval remained outstanding and the closing timing was uncertain.
- Asbestos claims totaled 8,050 at June 30, with an asbestos liability of $90.4 million. Six-month asbestos-related expense was approximately $6.0 million, net of insurance.
- The company had $751 million of unsatisfied or partially unsatisfied performance obligations, with approximately $276 million expected to be recognized as revenue during the remainder of 2023 and $475 million in 2024 and thereafter.
Outlook, Commentary and Risks
Management expects to return to growth in 2023, supported by increased backlog and improved served end-markets. It expects supply-chain, logistics and labor-availability headwinds to continue, but does not currently expect increased backlog cancellations. Management believes existing cash, operating cash flow and available credit will be sufficient for short- and long-term needs.
- Key risks include supply-chain disruption, inflation, raw-material costs, foreign-exchange volatility, interest rates, customer capital spending, backlog conversion and potential order delays or cancellations.
- International operations expose Flowserve to geopolitical conflict, sanctions, export controls, emerging-market collections and currency movements. A 10% change in foreign-currency rates was estimated to affect six-month net earnings by approximately $1 million, excluding indirect effects and the impact of foreign-exchange forwards.
- Other risks include asbestos and other litigation, pension obligations, tax audits and valuation allowances, acquisition approval and integration, execution of realignment savings, cybersecurity, environmental liabilities and competitive conditions.
- Management estimated a potential reduction in tax expense of approximately $15 million within the next 12 months from tax-audit resolutions or statute expirations, although timing and realization are uncertain.
- Management concluded that disclosure controls and procedures were effective as of June 30, 2023, with no material changes in internal control over financial reporting.
Investor Verification Items
- Verify whether the improved gross and operating margins are sustained after excluding pricing benefits, realignment charges and other non-recurring items.
- Monitor inventory growth, working-capital conversion and the sustainability of positive operating cash flow.
- Confirm the timing, financing and final terms of the proposed Velan acquisition, including the pending French approval.
- Track revolver borrowings, term-loan repayments, interest costs and compliance with credit-facility covenants.
- Assess backlog conversion, bookings quality and any cancellations, particularly in oil and gas, chemical, power-generation and water-management markets.
- Evaluate the actual costs and savings delivered by the 2023 Realignment Program against management’s approximately $40 million investment and $16 million 2024 run-rate savings expectations.
- Review asbestos claims, insurance recoveries, tax audits and potential valuation-allowance releases for changes that could materially affect earnings or cash flow.