Flowserve Corporation — Form 10-Q Summary
Business context and reporting period
Flowserve manufactures engineered flow-control equipment and provides aftermarket services through its Flowserve Pump Division and Flow Control Division. Its products serve oil and gas, chemical, power generation, water management and general industrial markets. The filing covers the unaudited quarter and six months ended June 30, 2022, compared with the corresponding 2021 periods.
Financial performance and liquidity
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Sales | $882.2 million | $898.2 million | $1,703.3 million | $1,755.5 million |
| Gross profit | $249.8 million | $278.2 million | $459.5 million | $529.1 million |
| Gross margin | 28.3% | 31.0% | 27.0% | 30.1% |
| Operating income | $60.3 million | $72.2 million | $67.7 million | $128.3 million |
| Operating margin | 6.8% | 8.0% | 4.0% | 7.3% |
| Net earnings attributable to Flowserve | $44.8 million | $45.4 million | $29.0 million | $59.4 million |
| Diluted EPS | $0.34 | $0.35 | $0.22 | $0.45 |
Bookings increased 9.6% in the quarter to $1,044.0 million and 12.3% year to date to $2,129.7 million. Backlog was $2,316.2 million at June 30, 2022, up 15.6% from December 31, 2021, despite approximately $25.2 million of Russia-related cancellations and approximately $73 million of unfavorable currency effects. Aftermarket represented approximately 53% of sales in both comparable periods.
Operating cash flow was negative $71.4 million in the first six months of 2022, compared with positive $61.3 million in 2021. The deterioration primarily reflected a $96.7 million inventory investment, a $21.6 million use of cash from receivables, a $7.7 million use from contract assets and a $65.8 million use from accrued liabilities and income taxes, including an approximately $30 million withholding-tax payment. Capital expenditures were $31.0 million.
Cash and cash equivalents were $458.3 million at June 30, 2022, down from $658.5 million at year-end 2021. Total debt and finance lease obligations were $1.288 billion, including $46.3 million due within one year and $1.242 billion due thereafter. The company had $277.1 million of available borrowing capacity under its revolving credit facility, no revolving loans outstanding, and $66.2 million of letters of credit. It was in compliance with applicable debt covenants.
Material changes versus the prior comparable period
- Second-quarter sales declined 1.8%; first-half sales declined 3.0%. Negative currency effects were approximately $41 million in the quarter and $60 million year to date.
- Gross margin declined 270 basis points in the quarter and 310 basis points year to date, driven by lower-margin original-equipment revenue, slower backlog conversion, freight and logistics costs, labor constraints and manufacturing under-absorption.
- First-half operating income fell 47.2%, while attributable net earnings declined 51.3%. The year-to-date comparison was also affected by a $20.2 million pretax Russia-related charge in 2022 and a $7.6 million debt-extinguishment loss in 2021.
- Interest expense declined to $11.1 million in the quarter and $21.8 million year to date, primarily due to lower effective borrowing rates and reduced debt.
- The effective tax rate increased to 20.1% in the quarter and 31.4% year to date, compared with 5.4% and 9.1%, respectively, in 2021. The year-to-date rate reflected the current and anticipated tax effects of the Russia-Ukraine conflict.
- Other comprehensive loss was $57.6 million in the quarter and $70.7 million year to date, largely due to foreign-currency translation losses.
Guidance, outlook, risks and unusual items
Management expects growth in 2022 supported by improved commodity prices, market conditions, bookings and backlog. It expects to continue delivering backlog, although supply-chain, logistics and labor constraints are extending cycle times. Management does not expect a material increase in backlog cancellations and believes planned cost savings will support adequate liquidity over both the next 12 months and longer term. Estimated 2022 capital expenditures are $60 million to $70 million, excluding acquisitions.
Flowserve permanently ceased operations in Russia. The company recorded a $20.2 million pretax charge, or $21.0 million after tax, in the first quarter for asset reserves, contract cancellations, exit costs and related exposure; management concluded no additional material reserve was required at June 30. The company does not currently expect incremental Russia-related effects to be material.
Principal risks include COVID-19 disruptions, supply-chain and freight inflation, labor availability, slower conversion of backlog, customer capital-spending weakness, oil and gas exposure, foreign-currency volatility, geopolitical and sanctions risk, receivable collectability, fixed-price project overruns, supplier performance, debt-market access, tax valuation allowances, pension obligations and asbestos litigation. Active asbestos claims totaled 8,917 at June 30, 2022, with an asbestos liability of $90.1 million. Management believes existing reserves and expected insurance or indemnity recoveries are reasonable, but acknowledges significant uncertainty.
The company had $413.9 million of foreign-exchange forward contracts outstanding and €423.2 million of cross-currency swap notional value at June 30, 2022. A 10% change in foreign exchange rates was estimated to affect net earnings by approximately $3 million over the six-month period, excluding the effect of foreign-exchange forwards.
Important facts for investors to verify
- Whether higher bookings and the $2.316 billion backlog convert to revenue at acceptable margins despite supply-chain, labor and logistics constraints.
- Inventory growth, receivable collection, working-capital requirements and the ability to restore positive operating cash flow.
- The sustainability of the $458.3 million cash balance and $277.1 million of available revolver capacity relative to debt maturities, dividends and planned pension contributions.
- Further Russia-Ukraine exposure, contract cancellations, sanctions effects and whether the existing $20.2 million reserve remains sufficient.
- Whether gross and operating margins recover from the year-to-date declines and whether cost savings offset inflation and manufacturing under-absorption.
- Changes in tax rates, tax audits and potential releases of foreign deferred-tax valuation allowances.
- Future asbestos claims, insurance recoveries and other litigation outcomes, including potential amounts beyond recorded reserves.