UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☑ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2022
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 1-13179
FLOWSERVE CORPORATION
(Exact name of registrant as specified in its charter)
| New York | 31-0267900 | |||||||||||||
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||||||||
| 5215 N. O’Connor Blvd., Suite 700, | Irving, | Texas | 75039 | |||||||||||
| (Address of principal executive offices) | (Zip Code) | |||||||||||||
| ( | 972 | ) | 443-6500 | |||||||||||||||||||||||
(Registrant’s telephone number, including area code) | ||||||||||||||||||||||||||
| Former name, former address and former fiscal year, if changed since last report: N/A | ||||||||||||||||||||||||||
Securities registered pursuant to Section 12(b) of the Act: | ||||||||||||||||||||||||||
Title of each class | Trading Symbol | Name of Each Exchange on Which Registered | ||||||||||||||||||||||||
| Common Stock, $1.25 Par Value | FLS | New York Stock Exchange | ||||||||||||||||||||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☑ Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☑ Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☑ | Accelerated filer | ☐ | Non-accelerated filer | ☐ | ||||||||||||
| Smaller reporting company | ☐ | Emerging growth company | ☐ | ||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑
As of October 25, 2022 there were 130,695,866 shares of the issuer’s common stock outstanding.
FLOWSERVE CORPORATION
FORM 10-Q
TABLE OF CONTENTS
| Page | |||||
| No. | |||||
i
PART I — FINANCIAL INFORMATION
Item 1.Financial Statements
FLOWSERVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
| (Amounts in thousands, except per share data) | Three Months Ended September 30, | ||||||||||
| 2022 | 2021 | ||||||||||
| Sales | $ | 872,881 | $ | 866,118 | |||||||
| Cost of sales | (633,304) | (612,626) | |||||||||
| Gross profit | 239,577 | 253,492 | |||||||||
| Selling, general and administrative expense | (221,142) | (200,862) | |||||||||
| Net earnings from affiliates | 5,782 | 4,732 | |||||||||
| Operating income | 24,217 | 57,362 | |||||||||
| Interest expense | (11,582) | (14,746) | |||||||||
| Loss on extinguishment of debt | — | (563) | |||||||||
| Interest income | 1,141 | 827 | |||||||||
| Other income (expense), net | 28,676 | (1,504) | |||||||||
| Earnings before income taxes | 42,452 | 41,376 | |||||||||
| (Provision for) benefit from income taxes | (1,817) | 10,433 | |||||||||
| Net earnings, including noncontrolling interests | 40,635 | 51,809 | |||||||||
| Less: Net earnings attributable to noncontrolling interests | (2,235) | (2,024) | |||||||||
| Net earnings attributable to Flowserve Corporation | $ | 38,400 | $ | 49,785 | |||||||
| Net earnings per share attributable to Flowserve Corporation common shareholders: | |||||||||||
| Basic | $ | 0.29 | $ | 0.38 | |||||||
| Diluted | 0.29 | 0.38 | |||||||||
| Weighted average shares - basic | 130,703 | 130,242 | |||||||||
| Weighted average shares - diluted | 131,402 | 130,789 | |||||||||
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
| (Amounts in thousands) | Three Months Ended September 30, | ||||||||||
| 2022 | 2021 | ||||||||||
| Net earnings, including noncontrolling interests | $ | 40,635 | $ | 51,809 | |||||||
| Other comprehensive income (loss): | |||||||||||
Foreign currency translation adjustments, net of taxes of $(3,183) and $(1,274), respectively | (89,282) | (15,561) | |||||||||
Pension and other postretirement effects, net of taxes of $(213) and $(471), respectively | 6,161 | 4,955 | |||||||||
Cash flow hedging activity, net of taxes of $(9) and $414, respectively | 29 | (1,347) | |||||||||
| Other comprehensive income (loss) | (83,092) | (11,953) | |||||||||
| Comprehensive income (loss), including noncontrolling interests | (42,457) | 39,856 | |||||||||
| Comprehensive (income) loss attributable to noncontrolling interests | (2,144) | (2,021) | |||||||||
| Comprehensive income (loss) attributable to Flowserve Corporation | $ | (44,601) | $ | 37,835 | |||||||
See accompanying notes to condensed consolidated financial statements.
1
FLOWSERVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
| (Amounts in thousands, except per share data) | Nine Months Ended September 30, | ||||||||||
| 2022 | 2021 | ||||||||||
| Sales | $ | 2,576,161 | $ | 2,621,604 | |||||||
| Cost of sales | (1,877,108) | (1,838,974) | |||||||||
| Gross profit | 699,053 | 782,630 | |||||||||
| Selling, general and administrative expense | (621,956) | (609,965) | |||||||||
Gain on sale of business | — | 1,806 | |||||||||
| Net earnings from affiliates | 14,821 | 11,157 | |||||||||
| Operating income | 91,918 | 185,628 | |||||||||
| Interest expense | (33,337) | (45,847) | |||||||||
| Loss on extinguishment of debt | — | (8,173) | |||||||||
| Interest income | 2,938 | 1,893 | |||||||||
| Other income (expense), net | 28,152 | (20,717) | |||||||||
| Earnings before income taxes | 89,671 | 112,784 | |||||||||
| (Provision for) benefit from income taxes | (16,618) | 3,929 | |||||||||
| Net earnings, including noncontrolling interests | 73,053 | 116,713 | |||||||||
| Less: Net earnings attributable to noncontrolling interests | (5,694) | (7,495) | |||||||||
| Net earnings attributable to Flowserve Corporation | $ | 67,359 | $ | 109,218 | |||||||
| Net earnings per share attributable to Flowserve Corporation common shareholders: | |||||||||||
| Basic | $ | 0.52 | $ | 0.84 | |||||||
| Diluted | 0.51 | 0.83 | |||||||||
| Weighted average shares - basic | 130,604 | 130,325 | |||||||||
| Weighted average shares - diluted | 131,233 | 130,867 | |||||||||
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
| (Amounts in thousands) | Nine Months Ended September 30, | ||||||||||
| 2022 | 2021 | ||||||||||
| Net earnings, including noncontrolling interests | $ | 73,053 | $ | 116,713 | |||||||
| Other comprehensive income (loss): | |||||||||||
Foreign currency translation adjustments, net of taxes of $(23,788) and $(7,021), respectively | (170,187) | (12,452) | |||||||||
Pension and other postretirement effects, net of taxes of $(925) and $(1,414), respectively | 16,318 | 11,273 | |||||||||
Cash flow hedging activity, net of taxes of $(27) and $348, respectively | 87 | (1,130) | |||||||||
| Other comprehensive income (loss) | (153,782) | (2,309) | |||||||||
| Comprehensive income (loss), including noncontrolling interests | (80,729) | 114,404 | |||||||||
| Comprehensive (income) loss attributable to noncontrolling interests | (6,941) | (7,654) | |||||||||
| Comprehensive income (loss) attributable to Flowserve Corporation | $ | (87,670) | $ | 106,750 | |||||||
See accompanying notes to condensed consolidated financial statements.
2
FLOWSERVE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
| (Amounts in thousands, except par value) | September 30, | December 31, | |||||||||
| 2022 | 2021 | ||||||||||
| ASSETS | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | 351,870 | $ | 658,452 | |||||||
Accounts receivable, net of allowance for expected credit losses of $82,101 and $74,336, respectively | 770,152 | 739,210 | |||||||||
Contract assets, net of allowance for expected credit losses of $3,999 and $2,393, respectively | 205,236 | 195,598 | |||||||||
| Inventories, net | 779,449 | 678,287 | |||||||||
| Prepaid expenses and other | 117,077 | 117,130 | |||||||||
| Total current assets | 2,223,784 | 2,388,677 | |||||||||
Property, plant and equipment, net of accumulated depreciation of $1,135,437 and $1,191,823, respectively | 473,224 | 515,927 | |||||||||
| Operating lease right-of-use assets, net | 173,442 | 193,863 | |||||||||
| Goodwill | 1,135,538 | 1,196,479 | |||||||||
| Deferred taxes | 44,833 | 44,049 | |||||||||
| Other intangible assets, net | 134,105 | 152,463 | |||||||||
Other assets, net of allowance for expected credit losses of $66,210 and $67,696, respectively | 321,062 | 258,310 | |||||||||
| Total assets | $ | 4,505,988 | $ | 4,749,768 | |||||||
| LIABILITIES AND EQUITY | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | 414,372 | $ | 410,062 | |||||||
| Accrued liabilities | 382,535 | 445,092 | |||||||||
| Contract liabilities | 216,094 | 202,965 | |||||||||
| Debt due within one year | 47,962 | 41,058 | |||||||||
| Operating lease liabilities | 30,723 | 32,628 | |||||||||
| Total current liabilities | 1,091,686 | 1,131,805 | |||||||||
| Long-term debt due after one year | 1,232,248 | 1,261,770 | |||||||||
| Operating lease liabilities | 155,328 | 166,786 | |||||||||
| Retirement obligations and other liabilities | 334,967 | 352,062 | |||||||||
| Commitments and contingencies (See Note 10) | |||||||||||
| Shareholders’ equity: | |||||||||||
Common shares, $1.25 par value | 220,991 | 220,991 | |||||||||
Shares authorized – 305,000 | |||||||||||
Shares issued – 176,793 | |||||||||||
| Capital in excess of par value | 506,744 | 506,386 | |||||||||
| Retained earnings | 3,678,817 | 3,691,023 | |||||||||
Treasury shares, at cost – 46,376 and 46,794 shares, respectively | (2,037,758) | (2,057,706) | |||||||||
| Deferred compensation obligation | 6,950 | 7,214 | |||||||||
| Accumulated other comprehensive loss | (718,619) | (563,589) | |||||||||
| Total Flowserve Corporation shareholders’ equity | 1,657,125 | 1,804,319 | |||||||||
| Noncontrolling interests | 34,634 | 33,026 | |||||||||
| Total equity | 1,691,759 | 1,837,345 | |||||||||
| Total liabilities and equity | $ | 4,505,988 | $ | 4,749,768 | |||||||
See accompanying notes to condensed consolidated financial statements.
3
FLOWSERVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited)
| Total Flowserve Corporation Shareholders’ Equity | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Capital in Excess of Par Value | Retained Earnings | Deferred Compensation Obligation | Accumulated Other Comprehensive Income (Loss) | Total Equity | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Common Stock | Treasury Stock | Non- controlling Interests | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (Amounts in thousands) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance — July 1, 2022 | 176,793 | $ | 220,991 | $ | 500,013 | $ | 3,666,935 | (46,377) | $ | (2,037,839) | $ | 6,921 | $ | (635,618) | $ | 32,490 | $ | 1,753,893 | |||||||||||||||||||||||||||||||||||||||||
| Stock activity under stock plans | — | — | (129) | — | 1 | 81 | 29 | — | — | (19) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | 6,860 | — | — | — | — | — | — | 6,860 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Net earnings | — | — | — | 38,400 | — | — | — | — | 2,235 | 40,635 | |||||||||||||||||||||||||||||||||||||||||||||||||
| Cash dividends declared | — | — | — | (26,518) | — | — | — | — | — | (26,518) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | — | — | — | (83,001) | (91) | (83,092) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Balance — September 30, 2022 | 176,793 | $ | 220,991 | $ | 506,744 | $ | 3,678,817 | (46,376) | $ | (2,037,758) | $ | 6,950 | $ | (718,619) | $ | 34,634 | $ | 1,691,759 | |||||||||||||||||||||||||||||||||||||||||
| Balance — July 1, 2021 | 176,793 | $ | 220,991 | $ | 494,221 | $ | 3,677,117 | (46,806) | $ | (2,058,279) | $ | 7,077 | $ | (600,143) | $ | 29,708 | $ | 1,770,692 | |||||||||||||||||||||||||||||||||||||||||
| Stock activity under stock plans | — | — | (237) | — | 2 | 111 | 68 | — | — | (58) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | 7,138 | — | — | — | — | — | — | 7,138 | |||||||||||||||||||||||||||||||||||||||||||||||||
| Net earnings | — | — | — | 49,785 | — | — | — | — | 2,024 | 51,809 | |||||||||||||||||||||||||||||||||||||||||||||||||
| Cash dividends declared | — | — | — | (26,395) | — | — | — | — | — | (26,395) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | — | — | — | (11,950) | (3) | (11,953) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Balance — September 30, 2021 | 176,793 | $ | 220,991 | $ | 501,122 | $ | 3,700,507 | (46,804) | $ | (2,058,168) | $ | 7,145 | $ | (612,093) | $ | 31,729 | $ | 1,791,233 | |||||||||||||||||||||||||||||||||||||||||
| See accompanying notes to condensed consolidated financial statements. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
4
FLOWSERVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited)
| Total Flowserve Corporation Shareholders’ Equity | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Capital in Excess of Par Value | Retained Earnings | Deferred Compensation Obligation | Accumulated Other Comprehensive Income (Loss) | Total Equity | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Common Stock | Treasury Stock | Non- controlling Interests | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (Amounts in thousands) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance — January 1, 2022 | 176,793 | $ | 220,991 | $ | 506,386 | $ | 3,691,023 | (46,794) | $ | (2,057,706) | $ | 7,214 | $ | (563,589) | $ | 33,026 | $ | 1,837,345 | |||||||||||||||||||||||||||||||||||||||||
| Stock activity under stock plans | — | — | (23,399) | — | 418 | 19,948 | (264) | — | — | (3,715) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | 23,757 | — | — | — | — | — | — | 23,757 | |||||||||||||||||||||||||||||||||||||||||||||||||
| Net earnings | — | — | — | 67,359 | — | — | — | — | 5,694 | 73,053 | |||||||||||||||||||||||||||||||||||||||||||||||||
| Cash dividends declared | — | — | — | (79,565) | — | — | — | — | — | (79,565) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | — | — | — | (155,030) | 1,248 | (153,782) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Other, net | — | — | — | — | — | — | — | — | (5,334) | (5,334) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Balance — September 30, 2022 | 176,793 | $ | 220,991 | $ | 506,744 | $ | 3,678,817 | (46,376) | $ | (2,037,758) | $ | 6,950 | $ | (718,619) | $ | 34,634 | $ | 1,691,759 | |||||||||||||||||||||||||||||||||||||||||
| Balance — January 1, 2021 | 176,793 | $ | 220,991 | $ | 502,227 | $ | 3,670,543 | (46,768) | $ | (2,059,309) | $ | 6,164 | $ | (609,625) | $ | 30,330 | $ | 1,761,321 | |||||||||||||||||||||||||||||||||||||||||
| Stock activity under stock plans | — | — | (24,715) | — | 404 | 18,672 | 981 | — | — | (5,062) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | 23,610 | — | — | — | — | — | — | 23,610 | |||||||||||||||||||||||||||||||||||||||||||||||||
| Net earnings | — | — | — | 109,218 | — | — | — | — | 7,495 | 116,713 | |||||||||||||||||||||||||||||||||||||||||||||||||
| Cash dividends declared | — | — | — | (79,254) | — | — | — | — | — | (79,254) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Repurchases of common shares | — | — | — | — | (440) | (17,531) | — | — | — | (17,531) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | — | — | — | (2,468) | 159 | (2,309) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Other, net | — | — | — | — | — | — | — | — | (6,255) | (6,255) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Balance — September 30, 2021 | 176,793 | $ | 220,991 | $ | 501,122 | $ | 3,700,507 | (46,804) | $ | (2,058,168) | $ | 7,145 | $ | (612,093) | $ | 31,729 | $ | 1,791,233 | |||||||||||||||||||||||||||||||||||||||||
| See accompanying notes to condensed consolidated financial statements. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
5
FLOWSERVE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| (Amounts in thousands) | Nine Months Ended September 30, | ||||||||||
| 2022 | 2021 | ||||||||||
| Cash flows – Operating activities: | |||||||||||
| Net earnings, including noncontrolling interests | $ | 73,053 | $ | 116,713 | |||||||
| Adjustments to reconcile net earnings to net cash provided (used) by operating activities: | |||||||||||
| Depreciation | 59,207 | 66,316 | |||||||||
| Amortization of intangible and other assets | 10,051 | 10,643 | |||||||||
| Loss on extinguishment of debt | — | 8,173 | |||||||||
| Stock-based compensation | 23,757 | 23,610 | |||||||||
| Foreign currency, asset write downs and other non-cash adjustments | (24,085) | 9,897 | |||||||||
| Change in assets and liabilities: | |||||||||||
| Accounts receivable, net | (78,376) | 24,361 | |||||||||
| Inventories, net | (151,938) | (47,533) | |||||||||
| Contract assets, net | (21,912) | 35,358 | |||||||||
| Prepaid expenses and other, net | (14,881) | 2,429 | |||||||||
| Accounts payable | 29,307 | (58,600) | |||||||||
| Contract liabilities | 27,237 | 9,379 | |||||||||
| Accrued liabilities and income taxes payable | (32,735) | 9,136 | |||||||||
| Retirement obligations and other liabilities | 24,123 | (23,842) | |||||||||
| Net deferred taxes | (32,293) | (34,933) | |||||||||
| Net cash flows provided (used) by operating activities | (109,485) | 151,107 | |||||||||
| Cash flows – Investing activities: | |||||||||||
| Capital expenditures | (45,831) | (34,034) | |||||||||
| Other | 184 | (4,679) | |||||||||
| Net cash flows provided (used) by investing activities | (45,647) | (38,713) | |||||||||
| Cash flows – Financing activities: | |||||||||||
| Payments on senior notes | — | (407,473) | |||||||||
| Proceeds from issuance of senior notes | — | 498,280 | |||||||||
| Proceeds from long-term debt | — | 300,000 | |||||||||
| Payments of deferred loan cost | — | (5,399) | |||||||||
| Payments on term loan | (24,239) | — | |||||||||
| Proceeds under other financing arrangements | 1,135 | 1,408 | |||||||||
| Payments under other financing arrangements | (356) | (6,215) | |||||||||
| Repurchases of common shares | — | (17,531) | |||||||||
| Payments related to tax withholding for stock-based compensation | (4,578) | (5,899) | |||||||||
| Payments of dividends | (78,406) | (78,551) | |||||||||
| Other | (5,334) | (6,276) | |||||||||
| Net cash flows provided (used) by financing activities | (111,778) | 272,344 | |||||||||
| Effect of exchange rate changes on cash | (39,672) | (22,743) | |||||||||
| Net change in cash and cash equivalents | (306,582) | 361,995 | |||||||||
| Cash and cash equivalents at beginning of period | 658,452 | 1,095,274 | |||||||||
| Cash and cash equivalents at end of period | $ | 351,870 | $ | 1,457,269 | |||||||
See accompanying notes to condensed consolidated financial statements.
6
FLOWSERVE CORPORATION
(Unaudited)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1.Basis of Presentation and Accounting Policies
Basis of Presentation
The accompanying condensed consolidated balance sheet as of September 30, 2022 and December 31, 2021, and the related condensed consolidated statements of income, condensed consolidated statements of comprehensive income (loss), condensed consolidated statements of shareholders' equity for the three and nine months ended September 30, 2022 and 2021 and condensed consolidated statements of cash flows for the nine months ended September 30, 2022 and 2021 of Flowserve Corporation are unaudited. In management’s opinion, all adjustments comprising normal recurring adjustments necessary for fair statement of such condensed consolidated financial statements have been made. Prior period information has been updated to conform to current year presentation.
The accompanying condensed consolidated financial statements and notes in this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2022 ("Quarterly Report") are presented as permitted by Regulation S-X and do not contain certain information included in our annual financial statements and notes thereto. Accordingly, the accompanying condensed consolidated financial information should be read in conjunction with the audited consolidated financial statements presented in our Annual Report on Form 10-K for the year ended December 31, 2021 ("2021 Annual Report").
Coronavirus Pandemic ("COVID-19") - During the first nine months of 2022, we continued to respond to the macroeconomic and global economic impacts caused by COVID-19. Many of our suppliers have experienced varying lengths of production and shipping delays related to the effects of COVID-19. These conditions have had an adverse impact on the speed at which we can manufacture and ship our products to customers, and have also led to an increase in logistics, transportation and freight costs. As a result of the macroeconomic impacts, we have also experienced labor constraints and inflationary pressures. The Company's condensed consolidated financial statements presented reflect management's estimates and assumptions regarding the effects of COVID-19 as of the date of the condensed consolidated financial statements.
Russia and Ukraine Conflict - In response to the ongoing military conflict in Ukraine, several countries, including the United States, have imposed economic sanctions and export controls on certain industry sectors and parties in Russia. As a result of this conflict, including the aforementioned sanctions and overall instability in the region, in February 2022 we stopped accepting new orders in Russia and temporarily suspended fulfillment of existing orders. In March 2022, we made the decision to permanently cease all Company operations in Russia. We have commenced the necessary actions to cease operations of our Russian subsidiary, including taking steps to cancel existing contracts with customers, terminate our approximately 50 Russia-based employees and terminate other related contractual commitments, and currently expect this process to be substantially complete by the end of 2022. As a result of the conflict and the resulting macroeconomic impacts we have also experienced supply shortages and inflationary pressures.
In 2021, our Russian subsidiary had approximately $14 million of sales with an additional $36 million of sales from certain of our other foreign subsidiaries into the Russian market. As of March 31, 2022, the net assets held on our Russian subsidiary's balance sheet were $2.7 million, including $7.1 million of cash, $3.6 million of accounts receivables, a $9.3 million net intercompany payable position and other immaterial amounts. In addition, certain of our other foreign subsidiaries had open contracts with Russian customers that were subsequently cancelled for which revenue had been previously recognized over time utilizing the percentage of completion ("POC") method. As a result of the above, in the first quarter of 2022 we recorded a $20.2 million pre-tax charge ($21.0 million after-tax) to reserve the asset positions of our Russian subsidiary (excluding cash) as of March 31, 2022, to record contra-revenue for previously recognized revenue and estimated cancellation fees on open contracts that were previously accounted for under POC and subsequently canceled, to establish a reserve for the estimated cost to exit the operations of our Russian subsidiary and to record a reserve for our estimated financial exposure on contracts that have or are anticipated to be cancelled. We reevaluated our financial exposure as of June 30, 2022 and September 30, 2022, and concluded that the reserve recorded as of March 31, 2022 is sufficient and no material changes to reserves were needed.
The following table presents the above impacts of the Russia pre-tax charge:
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| Nine Months Ended September 30, 2022 | |||||||||||||||||
| (Amounts in thousands) | Flowserve Pump Division | Flow Control Division | Consolidated Total | ||||||||||||||
| Sales | $ | (5,429) | $ | (2) | $ | (5,431) | |||||||||||
| Cost of sales ("COS") | 3,510 | 1,112 | 4,622 | ||||||||||||||
| Gross loss | (8,939) | (1,114) | (10,053) | ||||||||||||||
| Selling, general and administrative expense ("SG&A") | 9,111 | 1,082 | 10,193 | ||||||||||||||
| Operating loss | $ | (18,050) | $ | (2,196) | $ | (20,246) | |||||||||||
We continue to monitor the situation involving Russia and Ukraine and its impact on the rest of our global business. This includes the macroeconomic impact, including with respect to global supply chain issues and inflationary pressures. To date, these impacts have not been material to our business and we do not currently expect that any incremental impact in future quarters, including any financial impacts caused by our cancellation of customer contracts and ceasing of operations in Russia, will be material to the Company.
Prior Period Lease Accounting Correction - In conjunction with our close process for the third quarter of 2022, the Company identified an accounting error related to certain operating real estate leases that have escalating rent payments which were not correctly recorded on a straight-line basis in the amount of $6.4 million. Approximately $5.8 million of the error impacted the Company’s condensed consolidated statements of income prior to adoption of ASU No. 2016-02, Leases (Topic 842) in 2019 and the remaining immaterial amount impacted each period subsequent to adoption. To correct the cumulative impact of the error the Company recorded an adjustment of $6.4 million of incremental operating lease expense in the third quarter of 2022 ($5.5 million classified as SG&A and $0.9 million classified as COS), with the offsetting adjustment to reduce operating lease right-of-use assets, net on our condensed consolidated balance sheet for the period ended September 30, 2022. There was no impact to our condensed statements of cash flows as a result of the correction of the error.
Accounting Developments
Pronouncements Not Yet Implemented
In October 2021, the FASB issued ASU No. 2021-08, "Accounting for Contract Assets and Contract Liabilities from Contracts with Customers." The amendments in this Update improve comparability for both the recognition and measurement of acquired revenue contracts with customers at the date of and after a business combination. The amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years and should be applied prospectively to business combinations occurring on or after the effective date of the amendments. We do not expect the impact of this ASU to be material.
In November 2021, the FASB issued ASU No. 2021-10, "Government Assistance (Topic 832)." The amendments in this ASU do not change GAAP and, therefore, are not expected to result in a significant change in practice. Rather, the amendments aim to provide increased transparency by requiring business entities to disclose information about certain types of government assistance they receive in the notes to the financial statements. The amendments are effective for annual periods beginning after December 15, 2021 and can be applied either prospectively or retrospectively. We do not expect the impact of this ASU to be material.
In March 2022, the FASB issued ASU No. 2022-02, "Troubled Debt Restructurings and Vintage Disclosures." The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted the Current Expected Credit Loss ("CECL") model and enhance the disclosure requirements for loan refinancing and restructurings made with borrowers experiencing financial difficulty. In addition, the amendments require disclosure of current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures. The amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years and should be applied prospectively. We are evaluating the impact of this ASU on our disclosures.
In September 2022, the FASB issued ASU No. 2022-04, "Liabilities—Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations." The amendments require a buyer that uses supplier finance programs to make annual disclosures about the program’s key terms, the balance sheet presentation of related amounts, the confirmed amount outstanding at the end of the period, and associated roll-forward information. Only the amount outstanding at the end of the period must be disclosed in interim periods. The amendments are effective for all entities for fiscal years beginning after December 15, 2022 on a retrospective basis, including interim periods within those fiscal years, except for the requirement to disclose roll-forward information, which is effective prospectively for fiscal years beginning after December 15, 2023. We are evaluating the impact of this ASU on our disclosures.
8
2.Revenue Recognition
The majority of our revenues relate to customer orders that typically contain a single commitment of goods or services which have lead times under a year. Longer lead time, more complex contracts with our customers typically have multiple commitments of goods and services, including any combination of designing, developing, manufacturing, modifying, installing and commissioning of flow management equipment and providing services and parts related to the performance of such products. Control transfers over time when the customer is able to direct the use of and obtain substantially all of the benefits of the asset.
Our primary method for recognizing revenue over time is the POC method. Revenue from products and services transferred to customers over time accounted for approximately 12% and 15% of total revenue for the three month period ended September 30, 2022 and 2021, respectively, and 12% and 15% for the nine month period ended September 30, 2022 and 2021, respectively. If control does not transfer over time, then control transfers at a point in time. We recognize revenue at a point in time at the level of each performance obligation based on the evaluation of certain indicators of control transfer, such as title transfer, risk of loss transfer, customer acceptance and physical possession. Revenue from products and services transferred to customers at a point in time accounted for approximately 88% and 85% of total revenue for the three month period ended September 30, 2022 and 2021, respectively, and 88% and 85% for the nine month period ended September 30, 2022 and 2021, respectively. Refer to Note 3 to our consolidated financial statements included in our 2021 Annual Report for a more comprehensive discussion of our policies and accounting practices of revenue recognition.
Disaggregated Revenue
We conduct our operations through two business segments based on the type of product and how we manage the business:
•Flowserve Pump Division ("FPD") designs and manufactures custom, highly-engineered pumps, pre-configured industrial pumps, pump systems, mechanical seals, auxiliary systems and replacement parts and related services; and
•Flow Control Division ("FCD") designs, manufactures and distributes a broad portfolio of engineered-to-order and configured-to-order isolation valves, control valves, valve automation products and related equipment.
Our revenue sources are derived from our original equipment manufacturing and our aftermarket sales and services. Our original equipment revenues are generally related to originally designed, manufactured, distributed and installed equipment that can range from pre-configured, short-cycle products to more customized, highly-engineered equipment ("Original Equipment"). Our aftermarket sales and services are derived from sales of replacement equipment, as well as maintenance, advanced diagnostic, repair and retrofitting services ("Aftermarket"). Each of our two business segments generate Original Equipment and Aftermarket revenues.
The following tables present our customer revenues disaggregated by revenue source:
| Three Months Ended September 30, 2022 | |||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Total | ||||||||||||||
| Original Equipment | $ | 196,539 | $ | 215,550 | $ | 412,089 | |||||||||||
| Aftermarket | 394,807 | 65,985 | 460,792 | ||||||||||||||
| $ | 591,346 | $ | 281,535 | $ | 872,881 | ||||||||||||
| Three Months Ended September 30, 2021 | |||||||||||||||||
| FPD | FCD | Total | |||||||||||||||
| Original Equipment | $ | 223,358 | $ | 201,890 | $ | 425,248 | |||||||||||
| Aftermarket | 377,750 | 63,120 | 440,870 | ||||||||||||||
| $ | 601,108 | $ | 265,010 | $ | 866,118 | ||||||||||||
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| Nine Months Ended September 30, 2022 | |||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Total | ||||||||||||||
| Original Equipment | $ | 609,640 | $ | 596,989 | $ | 1,206,629 | |||||||||||
| Aftermarket | 1,170,117 | 199,415 | 1,369,532 | ||||||||||||||
| $ | 1,779,757 | $ | 796,404 | $ | 2,576,161 | ||||||||||||
| Nine Months Ended September 30, 2021 | |||||||||||||||||
| FPD | FCD | Total | |||||||||||||||
| Original Equipment | $ | 657,910 | $ | 608,707 | $ | 1,266,617 | |||||||||||
| Aftermarket | 1,162,798 | 192,189 | 1,354,987 | ||||||||||||||
| $ | 1,820,708 | $ | 800,896 | $ | 2,621,604 | ||||||||||||
Our customer sales are diversified geographically. The following tables present our revenues disaggregated by geography, based on the shipping addresses of our customers:
| Three Months Ended September 30, 2022 | |||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Total | ||||||||||||||
| North America(1) | $ | 249,968 | $ | 117,262 | $ | 367,230 | |||||||||||
| Latin America(2) | 49,063 | 6,959 | 56,022 | ||||||||||||||
| Middle East and Africa | 90,598 | 23,994 | 114,592 | ||||||||||||||
| Asia Pacific | 89,794 | 80,770 | 170,564 | ||||||||||||||
| Europe | 111,923 | 52,550 | 164,473 | ||||||||||||||
| $ | 591,346 | $ | 281,535 | $ | 872,881 | ||||||||||||
| Three Months Ended September 30, 2021 | |||||||||||||||||
| FPD | FCD | Total | |||||||||||||||
| North America(1) | $ | 230,130 | $ | 95,854 | $ | 325,984 | |||||||||||
| Latin America(2) | 63,443 | 7,320 | 70,763 | ||||||||||||||
| Middle East and Africa | 71,296 | 24,271 | 95,567 | ||||||||||||||
| Asia Pacific | 117,424 | 84,267 | 201,691 | ||||||||||||||
| Europe | 118,815 | 53,298 | 172,113 | ||||||||||||||
| $ | 601,108 | $ | 265,010 | $ | 866,118 | ||||||||||||
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| Nine Months Ended September 30, 2022 | |||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Total | ||||||||||||||
| North America(1) | $ | 754,337 | $ | 344,690 | $ | 1,099,027 | |||||||||||
| Latin America(2) | 144,974 | 17,463 | 162,437 | ||||||||||||||
| Middle East and Africa | 247,205 | 67,392 | 314,597 | ||||||||||||||
| Asia Pacific | 288,971 | 220,980 | 509,951 | ||||||||||||||
| Europe | 344,270 | 145,879 | 490,149 | ||||||||||||||
| $ | 1,779,757 | $ | 796,404 | $ | 2,576,161 | ||||||||||||
| Nine Months Ended September 30, 2021 | |||||||||||||||||
| FPD | FCD | Total | |||||||||||||||
| North America(1) | $ | 697,712 | $ | 284,217 | $ | 981,929 | |||||||||||
| Latin America(2) | 157,703 | 23,014 | 180,717 | ||||||||||||||
| Middle East and Africa | 223,502 | 78,503 | 302,005 | ||||||||||||||
| Asia Pacific | 361,450 | 251,864 | 613,314 | ||||||||||||||
| Europe | 380,341 | 163,298 | 543,639 | ||||||||||||||
| $ | 1,820,708 | $ | 800,896 | $ | 2,621,604 | ||||||||||||
__________________________________
(1) North America represents the United States and Canada.
(2) Latin America includes Mexico.
On September 30, 2022, the aggregate transaction price allocated to unsatisfied (or partially unsatisfied) performance obligations was approximately $597 million. We estimate recognition of approximately $155 million of this amount as revenue in the remainder of 2022 and an additional $442 million in 2023 and thereafter.
Contract Balances
We receive payment from customers based on a contractual billing schedule and specific performance requirements as established in our contracts. We record billings as accounts receivable when an unconditional right to consideration exists. A contract asset represents revenue recognized in advance of our right to receive payment under the terms of a contract. A contract liability represents our right to receive payment in advance of revenue recognized for a contract.
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The following tables present beginning and ending balances of contract assets and contract liabilities, current and long-term, for the nine months ended September 30, 2022 and 2021:
| (Amounts in thousands) | Contract Assets, net (Current) | Long-term Contract Assets, net(1) | Contract Liabilities (Current) | Long-term Contract Liabilities(2) | |||||||||||||||||||
| Beginning balance, January 1, 2022 | $ | 195,598 | $ | 426 | $ | 202,965 | $ | 464 | |||||||||||||||
| Revenue recognized that was included in contract liabilities at the beginning of the period | — | — | (133,730) | — | |||||||||||||||||||
| Revenue recognized in the period in excess of billings | 417,430 | — | — | — | |||||||||||||||||||
| Billings arising during the period in excess of revenue recognized | — | — | 155,584 | 7 | |||||||||||||||||||
| Amounts transferred from contract assets to receivables | (392,199) | (1,406) | — | — | |||||||||||||||||||
| Currency effects and other, net | (15,593) | 987 | (8,725) | (38) | |||||||||||||||||||
| Ending balance, September 30, 2022 | $ | 205,236 | $ | 7 | $ | 216,094 | $ | 433 | |||||||||||||||
| (Amounts in thousands) | Contract Assets, net (Current) | Long-term Contract Assets, net(1) | Contract Liabilities (Current) | Long-term Contract Liabilities(2) | |||||||||||||||||||
| Beginning balance, January 1, 2021 | $ | 277,734 | $ | 1,139 | $ | 194,227 | $ | 822 | |||||||||||||||
| Revenue recognized that was included in contract liabilities at the beginning of the period | — | — | (137,305) | — | |||||||||||||||||||
| Revenue recognized in the period in excess of billings | 539,813 | — | — | — | |||||||||||||||||||
| Billings arising during the period in excess of revenue recognized | — | — | 145,369 | — | |||||||||||||||||||
| Amounts transferred from contract assets to receivables | (563,145) | (61) | — | — | |||||||||||||||||||
| Currency effects and other, net | (18,485) | (109) | (3,188) | (40) | |||||||||||||||||||
| Ending balance, September 30, 2021 | $ | 235,917 | $ | 969 | $ | 199,103 | $ | 782 | |||||||||||||||
_____________________________________
(1) Included in other assets, net.
(2) Included in retirement obligations and other liabilities.
3.Allowance for Expected Credit Losses
The allowance for credit losses is an estimate of the credit losses expected over the life of our financial assets and instruments. We assess and measure expected credit losses on a collective basis when similar risk characteristics exist, including market, geography, credit risk and remaining duration. Financial assets and instruments that do not share risk characteristics are evaluated on an individual basis. Our estimate of the allowance is assessed and quantified using internal and external valuation information relating to past events, current conditions and reasonable and supportable forecasts over the contractual terms of an asset.
Our primary exposure to expected credit losses is through our trade receivables and contract assets. For these financial assets, we record an allowance for expected credit losses that, when deducted from the gross asset balance, presents the net amount expected to be collected. Primarily, our experience of historical credit losses provides the basis for our estimation of the allowance. We estimate the allowance based on an aging schedule and according to historical losses as determined from our history of billings and collections. Additionally, we adjust the allowance for factors that are specific to our customers’ credit risk such as financial difficulties, liquidity issues, insolvency, and country and geopolitical risks. We also consider both the current and forecasted macroeconomic conditions as of the reporting date. As identified and needed, we adjust the allowance and recognize adjustments in the income statement each period. Trade receivables are written off against the allowance in the period when the receivable is deemed to be uncollectible. Subsequent recoveries of previously written off amounts are reflected as a reduction to credit impairment losses in the condensed consolidated statements of income.
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Contract assets represent a conditional right to consideration for satisfied performance obligations that become a receivable when the conditions are satisfied. Generally, contract assets are recorded when contractual billing schedules differ from revenue recognition based on timing and are managed through the revenue recognition process. Based on our historical credit loss experience, the current expected credit loss for contract assets is estimated to be approximately 1% of the asset balance.
The following table presents the changes in the allowance for expected credit losses for our trade receivables and contract assets for the nine months ended September 30, 2022 and 2021:
| (Amounts in thousands) | Trade receivables | Contract assets | |||||||||
| Beginning balance, January 1, 2022 | $ | 74,336 | $ | 2,393 | |||||||
| Charges to cost and expenses, net of recoveries | 12,652 | 1,243 | |||||||||
| Write-offs | (792) | — | |||||||||
| Currency effects and other, net | (4,095) | 363 | |||||||||
| Ending balance, September 30, 2022 | $ | 82,101 | $ | 3,999 | |||||||
| Beginning balance, January 1, 2021 | $ | 75,176 | $ | 3,205 | |||||||
| Charges to cost and expenses, net of recoveries | 4,234 | — | |||||||||
| Write-offs | (2,015) | — | |||||||||
| Currency effects and other, net | (1,429) | (427) | |||||||||
| Ending balance, September 30, 2021 | $ | 75,966 | $ | 2,778 | |||||||
Our allowance on long-term receivables, included in other assets, net, represent receivables with collection periods longer than 12 months and the balance primarily consists of reserved receivables associated with the national oil company in Venezuela. The following table presents the changes in the allowance for long-term receivables for the nine months ended September 30, 2022 and 2021:
| (Amounts in thousands) | 2022 | 2021 | |||||||||
| Balance at January 1 | $ | 67,696 | $ | 67,842 | |||||||
| Currency effects and other, net | (1,486) | (145) | |||||||||
| Balance at September 30 | $ | 66,210 | $ | 67,697 | |||||||
We also have exposure to credit losses from off-balance sheet exposures, such as financial guarantees and standby letters of credit, where we believe the risk of loss is immaterial to our financial statements as of September 30, 2022.
4.Stock-Based Compensation Plans
We maintain the Flowserve Corporation 2020 Long-Term Incentive Plan (“2020 Plan”), which is a shareholder approved plan authorizing the issuance of 12,500,000 shares of our common stock in the form of restricted shares, restricted share units and performance-based units (collectively referred to as "Restricted Shares"), incentive stock options, non-statutory stock options, stock appreciation rights and bonus stock. Of the shares of common stock authorized under the 2020 Plan, 9,733,171 were available for issuance as of September 30, 2022. Restricted Shares primarily vest over a three year period. Restricted Shares granted to employees who retire and have achieved at least 55 years of age and 10 years of service continue to vest over the original vesting period ("55/10 Provision"). As of September 30, 2022, 114,943 stock options were outstanding. No stock options were granted or vested during the nine months ended September 30, 2022 and 2021.
Restricted Shares – Awards of Restricted Shares are valued at the closing market price of our common stock on the date of grant. The unearned compensation is amortized to compensation expense over the vesting period of the restricted shares, except for awards related to the 55/10 Provision which are expensed in the period granted. We had unearned compensation of $26.5 million and $24.2 million at September 30, 2022 and December 31, 2021, respectively, which is expected to be recognized over a remaining weighted-average period of approximately one year. These amounts will be recognized into net earnings in prospective periods as the awards vest. The total fair value of Restricted Shares vested during the three months ended September 30, 2022 and 2021 was $0.1 million and $0.2 million, respectively. The total fair value of Restricted Shares vested during the nine months ended September 30, 2022 and 2021 was $22.6 million and $24.6 million, respectively.
We recorded stock-based compensation expense of $5.3 million ($6.9 million pre-tax) and $5.5 million ($7.1 million pre-tax) for the three months ended September 30, 2022 and 2021, respectively. We recorded stock-based compensation expense of
13
$18.4 million ($23.8 million pre-tax) and $18.2 million ($23.6 million pre-tax) for the nine months ended September 30, 2022 and 2021, respectively.
The following table summarizes information regarding Restricted Shares:
| Nine Months Ended September 30, 2022 | |||||||||||
| Shares | Weighted Average Grant-Date Fair Value | ||||||||||
| Number of unvested shares: | |||||||||||
| Outstanding as of January 1, 2022 | 1,671,011 | $ | 43.06 | ||||||||
| Granted | 974,258 | 32.90 | |||||||||
| Vested | (525,948) | 43.01 | |||||||||
| Forfeited | (237,876) | 44.75 | |||||||||
| Outstanding as of September 30, 2022 | 1,881,445 | $ | 37.60 | ||||||||
Unvested Restricted Shares outstanding as of September 30, 2022 included approximately 481,000 units with performance-based vesting provisions issuable in common stock and vest upon the achievement of pre-defined performance metrics. Targets for outstanding performance awards are based on our average return on invested capital, total shareholder return ("TSR") or free cash flow as a percent of net income over a three-year period. Performance units issued in 2022 and 2021 include a secondary measure, relative TSR, which can increase or decrease the number of vesting units by 15% depending on the Company's performance versus peers. Performance units issued in 2020 have a vesting percentage between 0% and 200%, while the performance units issued in 2022 and 2021 have a vesting percentage up to 230%. Compensation expense is recognized ratably over a cliff-vesting period of 36 months, based on the fair value of our common stock on the date of grant, adjusted for actual forfeitures. During the performance period, earned and unearned compensation expense is adjusted based on changes in the expected achievement of the performance targets for all performance-based units granted except for the TSR-based units. Vesting provisions range from 0 to approximately 1,059,000 shares based on performance targets. As of September 30, 2022, we estimate vesting of approximately 410,000 shares based on expected achievement of performance targets.
5.Derivative Instruments and Hedges
Our risk management and foreign currency derivatives and hedging policy specifies the conditions under which we may enter into derivative contracts. See Notes 1 and 9 to our consolidated financial statements included in our 2021 Annual Report and Note 7 of this Quarterly Report for additional information on our derivatives. We enter into foreign exchange forward contracts to hedge our cash flow risks associated with transactions denominated in currencies other than the local currency of the operation engaging in the transaction. We have not elected hedge accounting for our foreign exchange forward contracts and the changes in the fair values are recognized immediately in our condensed consolidated statements of income.
Foreign exchange forward contracts with third parties had a notional value of $399.6 million and $425.2 million at September 30, 2022 and December 31, 2021, respectively. At September 30, 2022, the length of foreign exchange forward contracts currently in place ranged from 5 days to 29 months.
We are exposed to risk from credit-related losses resulting from nonperformance by counterparties to our financial instruments. We perform credit evaluations of our counterparties under foreign exchange forward contracts agreements and expect all counterparties to meet their obligations. We have not experienced credit losses from our counterparties.
The fair values of foreign exchange forward contracts are summarized below:
| September 30, | December 31, | ||||||||||
| (Amounts in thousands) | 2022 | 2021 | |||||||||
| Current derivative assets | $ | 5,016 | $ | 740 | |||||||
| Noncurrent derivative assets | — | 2 | |||||||||
| Current derivative liabilities | 7,051 | 2,924 | |||||||||
| Noncurrent derivative liabilities | 315 | 82 | |||||||||
Current and noncurrent derivative assets are reported in our condensed consolidated balance sheets in prepaid expenses and other and other assets, net, respectively. Current and noncurrent derivative liabilities are reported in our condensed consolidated balance sheets in accrued liabilities and retirement obligations and other liabilities, respectively.
The impact of net changes in the fair values of foreign exchange forward contracts are summarized below:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| (Amounts in thousands) | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||
| Gains (losses) recognized in income | $ | 1,245 | $ | (75) | $ | 1,478 | $ | 1,718 | |||||||||||||||
Gains and losses recognized in our condensed consolidated statements of income for foreign exchange forward contracts are classified as other income (expense), net.
As a means of managing the volatility of foreign currency exposure with the Euro/U.S. dollar exchange rate, we enter into cross-currency swap agreements as a hedge of our Euro investment in certain of our international subsidiaries. Accordingly, on April 14, 2021 and March 9, 2021, we entered into cross currency swap agreements, with both having termination dates of October 1, 2030 and the March 9, 2021 cross currency swap having an early termination date of March 11, 2025. Also, during the third quarter of 2020 we entered into a cross currency swap agreement with a termination date of October 1, 2030 and an early termination date of September 22, 2025. The swap agreements are designated as net investment hedges and as of September 30, 2022 the combined notional value of these swaps was €423.2 million. The swaps are classified as Level II under the fair value hierarchy.
The fair values of our cross-currency swaps are summarized below:
| September 30, | December 31, | ||||||||||
| (Amounts in thousands) | 2022 | 2021 | |||||||||
| Other assets, net | $ | 96,798 | $ | 23,129 | |||||||
We exclude the interest accruals on the swaps from the assessment of hedge effectiveness and recognize the interest accruals in earnings within interest expense. For each reporting period, the change in the fair value of the swaps attributable to changes in the spot rate and differences between the change in the fair value of the excluded components and the amounts recognized in earnings under the swap accrual process are reported in accumulated other comprehensive loss ("AOCL") on our consolidated balance sheet. For the three and nine months ending September 30, 2022, an interest accrual of $2.3 million and $6.4 million, respectively, was recognized within interest expense in our condensed consolidated statements of income. For the three and nine months ending September 30, 2021, an interest accrual of $1.9 million and $4.3 million, respectively, was recognized within interest expense.
The cumulative net investment hedge (gains) losses, net of deferred taxes, under cross-currency swaps recorded in AOCL on our condensed consolidated balance sheet are summarized below:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| (Amounts in thousands) | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||
| (Gain) loss-included component (1) | $ | (22,107) | $ | (8,869) | $ | (66,363) | $ | (8,684) | |||||||||||||||
| (Gain) loss-excluded component (2) | 839 | (3,647) | (7,669) | 243 | |||||||||||||||||||
| (Gain) loss recognized in AOCL | $ | (21,268) | $ | (12,516) | $ | (74,032) | $ | (8,441) | |||||||||||||||
_____________________________________________
(1) Change in the fair value of the swaps attributable to changes in spot rates.
(2) Change in the fair value of the swaps due to changes other than those attributable to spot rates.
In March 2015, we designated €255.7 million of our 1.25% EUR 2022 Senior Notes ("2022 Euro Senior Notes") as a net investment hedge of our Euro investment in certain of our international subsidiaries. On September 22, 2020, we increased the designated hedged value on the 2022 Euro Senior Notes to €336.3 million, which reflected the remaining balance of the 2022 Euro Senior Notes. For each reporting period, the change in the carrying value due to the remeasurement of the effective portion was reported in AOCL on our condensed consolidated balance sheet and the remaining change in the carrying value of the ineffective portion, if any, was recognized in other income (expense), net in our condensed consolidated statements of income. As a result of the redemption of our 2022 Euro Senior Notes in the first quarter of 2021, we dedesignated the hedged value of our net investment hedge.
Prior to the dedesignation, the cumulative impact recorded in AOCL on our condensed consolidated balance sheet from the change in carrying value due to the remeasurement of the effective portion of the net investment hedge is summarized below:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| (Amounts in thousands) | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||
| Loss recognized in AOCL | $ | — | $ | — | $ | — | $ | 29,554 | |||||||||||||||
We use the spot method to measure the effectiveness of our net investment hedges and evaluate the effectiveness on a prospective basis at the beginning of each quarter. We did not record any ineffectiveness during the three and nine months ended September 30, 2022 and 2021, respectively.
6.Debt
Debt, including finance lease obligations, net of discounts and debt issuance costs, consisted of:
| September 30, | December 31, | ||||||||||
| (Amounts in thousands, except percentages) | 2022 | 2021 | |||||||||
3.50% USD Senior Notes due October 1, 2030, net of unamortized discount and debt issuance costs of $5,195 and $5,611, respectively | $ | 494,805 | $ | 494,389 | |||||||
2.80% USD Senior Notes due January 15, 2032, net of unamortized discount and debt issuance costs of $5,865 and $6,273, respectively | 494,135 | 493,727 | |||||||||
Term Loan Facility, interest rate of 4.92% at September 30, 2022 and 1.45% at December 31, 2021, net of debt issuance costs of $492 and $639, respectively | 269,508 | 291,861 | |||||||||
| Finance lease obligations and other borrowings | 21,762 | 22,851 | |||||||||
| Debt and finance lease obligations | 1,280,210 | 1,302,828 | |||||||||
| Less amounts due within one year | 47,962 | 41,058 | |||||||||
| Total debt due after one year | $ | 1,232,248 | $ | 1,261,770 | |||||||
Senior Notes
On March 19, 2021, we redeemed the remaining $400.9 million of our 2022 Euro Senior Notes and recorded a loss on early extinguishment of $7.6 million in the first quarter of 2021, which included the impact of a $6.6 million make-whole premium.
Senior Credit Facility
As discussed in Note 13 to our consolidated financial statements included in our 2021 Annual Report, we amended our credit agreement ("Amended and Restated Credit Agreement") under our Senior Credit Facility ("Credit Facility") with Bank of America, N.A. ("Administrative Agent") and the other lenders to provide greater flexibility in maintaining adequate liquidity and access to available borrowings. The Amended and Restated Credit Agreement, (i) retained, from the previous credit agreement, the $800.0 million unsecured Revolving Credit Facility, which includes a $750.0 million sublimit for the issuance of letters of credit and a $30.0 million sublimit for swing line loans, (ii) provides for an up to $300 million unsecured Term Loan Facility (the "Term Loan"), (iii) extends the maturity date of the agreement to September 13, 2026, (iv) reduces commitment fees, (v) extends net leverage ratio covenant definition through the maturity of the agreement, and (vi) provides the ability to make certain adjustments to the otherwise applicable commitment fee, interest rate and letter of credit fees based on the Company’s performance against to-be-established key performance indicators with respect to certain of the Company’s environmental, social and governance targets.
The interest rates per annum applicable to the Revolving Credit Facility are unchanged under the Amended and Restated Credit Agreement. The interest rates per annum applicable to the Credit Facility, other than with respect to swing line loans, are LIBOR plus between 1.000% to 1.750%, depending on our debt rating by either Moody’s Investors Service, Inc. ("Moody's") or Standard & Poor’s Financial Services LLC ("S&P"), or, at our option, the Base Rate (as defined in the Amended and Restated Credit Agreement) plus between 0.000% to 0.750% depending on our debt rating by either Moody’s or S&P. At September 30, 2022, the interest rate on the Revolving Credit Facility was LIBOR plus 1.375% in the case of LIBOR loans and the Base Rate plus 0.375% in the case of Base Rate loans. In addition, a commitment fee is payable quarterly in arrears on the daily unused portions of the Credit Facility. The commitment fee will be between 0.080% and 0.250% of unused amounts under the Credit Facility depending on our debt rating by either Moody’s or S&P. The commitment fee was 0.175% (per annum) during the three and nine months ended September 30, 2022.
Under the terms and conditions of the Amended and Restated Credit Agreement, interest rates per annum applicable to the Term Loan are stated as LIBOR plus between 0.875% to 1.625%, depending on the Company’s debt rating by either Moody’s
or S&P, or, at the option of the Company, the Base Rate plus between 0.000% to 0.625% depending on the Company’s debt rating by either Moody’s or S&P.
As of September 30, 2022 and December 31, 2021, we had no revolving loans outstanding and we had outstanding letters of credit of $56.9 million and $78.3 million at September 30, 2022 and December 31, 2021, respectively. On October 14, 2022, the Company borrowed $45.0 million on the Revolving Credit Facility for general corporate purposes. After consideration of the financial covenants under our Senior Credit Facility and outstanding letters of credit, as of September 30, 2022, the amount available for borrowings was limited to $157.3 million. As of December 31, 2021, the amount available for borrowings under our Revolving Credit Facility was $614.2 million.
Our compliance with applicable financial covenants under the Senior Notes and Credit Facility are tested quarterly. We were in compliance with all applicable covenants as of September 30, 2022. We have scheduled repayments on our Term Loan of $10.0 million due in each of the subsequent four quarters through September 30, 2023.
7.Fair Value
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models may be applied. Assets and liabilities recorded at fair value in our condensed consolidated balance sheets are categorized by hierarchical levels based upon the level of judgment associated with the inputs used to measure their fair values. Recurring fair value measurements are limited to investments in derivative instruments. The fair value measurements of our derivative instruments are determined using models that maximize the use of the observable market inputs including interest rate curves and both forward and spot prices for currencies, and are classified as Level II under the fair value hierarchy. The fair values of our derivatives are included in Note 5.
The carrying value of our financial instruments as reflected in our condensed consolidated balance sheets approximates fair value, with the exception of our long-term debt. The estimated fair value of our long-term debt, excluding the Senior Notes, approximates the carrying value and is determined using Level II inputs under the fair value hierarchy. The carrying value of our debt is included in Note 6. The estimated fair value of our Senior Notes at September 30, 2022 was $769.0 million compared to the carrying value of $988.9 million. The estimated fair value of the Senior Notes is based on Level I quoted market rates. The carrying amounts of our other financial instruments (e.g., cash and cash equivalents, accounts receivable, net, accounts payable and short-term debt) approximated fair value due to their short-term nature at September 30, 2022 and December 31, 2021.
8.Inventories
Inventories, net consisted of the following:
| September 30, | December 31, | ||||||||||
| (Amounts in thousands) | 2022 | 2021 | |||||||||
| Raw materials | $ | 342,308 | $ | 318,348 | |||||||
| Work in process | 295,425 | 242,143 | |||||||||
| Finished goods | 236,584 | 213,096 | |||||||||
| Less: Excess and obsolete reserve | (94,868) | (95,300) | |||||||||
| Inventories, net | $ | 779,449 | $ | 678,287 | |||||||
14
9.Earnings Per Share
The following is a reconciliation of net earnings of Flowserve Corporation and weighted average shares for calculating net earnings per common share. Earnings per weighted average common share outstanding was calculated as follows:
| Three Months Ended September 30, | |||||||||||
| (Amounts in thousands, except per share data) | 2022 | 2021 | |||||||||
| Net earnings of Flowserve Corporation | $ | 38,400 | $ | 49,785 | |||||||
| Dividends on restricted shares not expected to vest | — | — | |||||||||
| Earnings attributable to common and participating shareholders | $ | 38,400 | $ | 49,785 | |||||||
| Weighted average shares: | |||||||||||
| Common stock | 130,662 | 130,210 | |||||||||
| Participating securities | 41 | 32 | |||||||||
| Denominator for basic earnings per common share | 130,703 | 130,242 | |||||||||
| Effect of potentially dilutive securities | 699 | 547 | |||||||||
| Denominator for diluted earnings per common share | 131,402 | 130,789 | |||||||||
| Earnings per common share: | |||||||||||
| Basic | $ | 0.29 | $ | 0.38 | |||||||
| Diluted | 0.29 | 0.38 | |||||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in thousands, except per share data) | 2022 | 2021 | |||||||||
| Net earnings of Flowserve Corporation | $ | 67,359 | $ | 109,218 | |||||||
| Dividends on restricted shares not expected to vest | — | — | |||||||||
| Earnings attributable to common and participating shareholders | $ | 67,359 | $ | 109,218 | |||||||
| Weighted average shares: | |||||||||||
| Common stock | 130,566 | 130,298 | |||||||||
| Participating securities | 38 | 27 | |||||||||
| Denominator for basic earnings per common share | 130,604 | 130,325 | |||||||||
| Effect of potentially dilutive securities | 629 | 542 | |||||||||
| Denominator for diluted earnings per common share | 131,233 | 130,867 | |||||||||
| Earnings per common share: | |||||||||||
| Basic | $ | 0.52 | $ | 0.84 | |||||||
| Diluted | 0.51 | 0.83 | |||||||||
Diluted earnings per share above is based upon the weighted average number of shares as determined for basic earnings per share plus shares potentially issuable in conjunction with stock options and Restricted Shares.
10.Legal Matters and Contingencies
Asbestos-Related Claims
We are a defendant in a substantial number of lawsuits that seek to recover damages for personal injury allegedly caused by exposure to asbestos-containing products manufactured and/or distributed by our heritage companies in the past. Typically, these lawsuits have been brought against multiple defendants in state and federal courts. While the overall number of asbestos-related claims in which we or our predecessors have been named has generally declined in recent years, there can be no assurance that this trend will continue, or that the average cost per claim to us will not further increase. Asbestos-containing materials incorporated into any such products were encapsulated and used as internal components of process equipment, and we do not believe that significant emission of asbestos fibers occurred during the use of this equipment.
Our practice is to vigorously contest and resolve these claims, and we have been successful in resolving a majority of claims with little or no payment, other than legal fees. Activity related to asbestos claims during the periods indicated was as follows:
15
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Beginning claims(1) | 8,917 | 8,559 | 8,712 | 8,366 | |||||||||||||||||||
| New claims | 568 | 625 | 1,863 | 1,857 | |||||||||||||||||||
| Resolved claims | (624) | (645) | (1,714) | (1,668) | |||||||||||||||||||
| Other(2) | (4) | 82 | (4) | 66 | |||||||||||||||||||
| Ending claims(1) | 8,857 | 8,621 | 8,857 | 8,621 | |||||||||||||||||||
____________________
(1) Beginning and ending claims data in each period excludes inactive claims, as the Company considers it unlikely that inactive cases will be pursued further by the respective plaintiffs. A claim is classified as inactive either due to inactivity over a period of three years or if designated as inactive by the applicable court.
(2) Represents the net change in claims as a result of the reclassification of active cases as inactive and inactive cases as active during the period indicated. Cases moved from active to inactive status are removed from the claims count without being accounted for as a "Resolved claim", and cases moved from inactive status to active status are added back to the claims count without being accounted for as a “New claim”.
The following table presents the changes in the estimated asbestos liability:
| (Amounts in thousands) | 2022 | 2021 | |||||||||
| Beginning balance, January 1, | $ | 94,423 | $ | 99,530 | |||||||
| Asbestos liability adjustments, net | 14,782 | 4,783 | |||||||||
| Cash payment activity | (4,231) | (5,681) | |||||||||
| Other, net | (3,350) | (931) | |||||||||
| Ending balance, September 30, | $ | 101,624 | $ | 97,701 | |||||||
During the three and nine months ended September 30, 2022 the Company incurred expenses (net of insurance) of approximately $9.4 million and $13.0 million, respectively, compared to $5.6 million and $10.1 million, respectively, for the same periods in 2021 to defend, resolve or otherwise dispose of outstanding claims, including legal and other related expenses. During the three months ended September 30, 2022 and 2021, the Company updated its annual actuarial study to estimate the liability for pending and future claims not yet asserted, and which are probable and estimable and recorded the expenses associated with the true-up to the actuarial study. These expenses are included within SG&A in our condensed consolidated statements of income.
The Company had cash inflows (outflows) (net of insurance and/or indemnity) to defend, resolve or otherwise dispose of outstanding claims, including legal and other related expenses of approximately $0.7 million and $(6.8) million, respectively, during the nine months ended September 30, 2022 and 2021, respectively.
Historically, a high percentage of resolved claims have been covered by applicable insurance or indemnities from other companies, and we believe that a substantial majority of existing claims should continue to be covered by insurance or indemnities, in whole or in part.
We believe that our reserve for asbestos claims and the receivable for recoveries from insurance carriers that we have recorded for these claims reflects reasonable and probable estimates of these amounts. Our estimate of our ultimate exposure for asbestos claims, however, is subject to significant uncertainties, including the timing and number and types of new claims, unfavorable court rulings, judgments or settlement terms and ultimate costs to settle. Additionally, the continued viability of carriers may also impact the amount of probable insurance recoveries. We believe that these uncertainties could have a material adverse impact on our business, financial condition, results of operations and cash flows, though we currently believe the likelihood is remote.
Additionally, we have claims pending against certain insurers that, if resolved more favorably than reflected in the recorded receivables, would result in discrete gains in the applicable quarter.
16
Other Claims
We are also a defendant in a number of other lawsuits, including product liability claims, that are insured, subject to the applicable deductibles, arising in the ordinary course of business, and we are also involved in other uninsured routine litigation incidental to our business. We currently believe none of such litigation, either individually or in the aggregate, is material to our business, operations or overall financial condition. However, litigation is inherently unpredictable, and resolutions or dispositions of claims or lawsuits by settlement or otherwise could have an adverse impact on our financial position, results of operations or cash flows for the reporting period in which any such resolution or disposition occurs.
Although none of the aforementioned potential liabilities can be quantified with absolute certainty except as otherwise indicated above, we have established or adjusted reserves covering exposures relating to contingencies, to the extent believed to be reasonably estimable and probable based on past experience and available facts. While additional exposures beyond these reserves could exist, they currently cannot be estimated. We will continue to evaluate and update the reserves as necessary and appropriate.
11.Pension and Postretirement Benefits
Components of the net periodic cost for pension and postretirement benefits for the three months ended September 30, 2022 and 2021 were as follows:
| U.S. Defined Benefit Plans | Non-U.S. Defined Benefit Plans | Postretirement Medical Benefits | |||||||||||||||||||||||||||||||||
| (Amounts in millions) | 2022 | 2021 | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||||||||
| Service cost | $ | 6.1 | $ | 6.3 | $ | 1.3 | $ | 1.8 | $ | — | $ | — | |||||||||||||||||||||||
| Interest cost | 3.3 | 2.9 | 1.3 | 1.3 | 0.1 | 0.1 | |||||||||||||||||||||||||||||
| Expected return on plan assets | (6.3) | (6.3) | (1.2) | (1.5) | — | — | |||||||||||||||||||||||||||||
| Amortization of unrecognized prior service cost and other costs | — | — | (0.1) | — | — | — | |||||||||||||||||||||||||||||
| Amortization of unrecognized net loss | 0.9 | 1.9 | 0.5 | 1.1 | 0.1 | — | |||||||||||||||||||||||||||||
| Net periodic cost recognized | $ | 4.0 | $ | 4.8 | $ | 1.8 | $ | 2.7 | $ | 0.2 | $ | 0.1 | |||||||||||||||||||||||
Components of the net periodic cost for pension and postretirement benefits for the nine months ended September 30, 2022 and 2021 were as follows:
| U.S. Defined Benefit Plans | Non-U.S. Defined Benefit Plans | Postretirement Medical Benefits | |||||||||||||||||||||||||||||||||
| (Amounts in millions) | 2022 | 2021 | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||||||||
| Service cost | $ | 18.5 | $ | 18.9 | $ | 4.3 | $ | 5.5 | $ | — | $ | — | |||||||||||||||||||||||
| Interest cost | 9.9 | 8.9 | 4.6 | 4.1 | 0.3 | 0.3 | |||||||||||||||||||||||||||||
| Expected return on plan assets | (19.0) | (19.0) | (4.1) | (4.6) | — | — | |||||||||||||||||||||||||||||
| Amortization of unrecognized prior service cost and other costs | 0.1 | 0.1 | 0.2 | 0.2 | 0.1 | 0.1 | |||||||||||||||||||||||||||||
| Amortization of unrecognized net loss | 2.6 | 5.8 | 1.9 | 3.3 | 0.2 | — | |||||||||||||||||||||||||||||
| Net periodic cost recognized | $ | 12.1 | $ | 14.7 | $ | 6.9 | $ | 8.5 | $ | 0.6 | $ | 0.4 | |||||||||||||||||||||||
The components of net periodic cost for pension and postretirement benefits other than service costs are included in other income (expense), net in our condensed consolidated statements of income.
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12.Shareholders’ Equity
Dividends – Generally, our dividend date-of-record is in the last month of the quarter, and the dividend is paid the following month. Any subsequent dividends will be reviewed by our Board of Directors and declared in its discretion.
Dividends declared per share were as follows:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Dividends declared per share | $ | 0.20 | $ | 0.20 | $ | 0.60 | $ | 0.60 | |||||||||||||||
Share Repurchase Program – In 2014, our Board of Directors approved a $500.0 million share repurchase authorization. Our share repurchase program does not have an expiration date and we reserve the right to limit or terminate the repurchase program at any time without notice.
We had no repurchases of shares of our outstanding common stock for both of the three months ended September 30, 2022 and 2021. We had no repurchases of shares of our outstanding common stock during the nine months ended September 30, 2022, compared to 440,000 shares repurchased for $17.5 million for the same period in 2021. As of September 30, 2022, we had $96.1 million of remaining capacity under our current share repurchase program.
13.Income Taxes
For the three months ended September 30, 2022, we earned $42.5 million before taxes and recorded a provision for income taxes of $1.8 million resulting in an effective tax rate of 4.2%. For the nine months ended September 30, 2022, we earned $89.7 million before taxes and recorded a provision for income taxes of $16.6 million resulting in an effective tax rate of 18.5%. The effective tax rate varied from the U.S. federal statutory rate for the three months ended September 30, 2022 primarily due to the mitigation of previously recorded BEAT liability and the net impact of foreign operations. The effective tax rate varied from the U.S. federal statutory rate for the nine months ended September 30, 2022 primarily due to the mitigation of previously recorded BEAT liability, the current and anticipated tax impact of the Russia-Ukraine conflict on our business and the net impact of foreign operations.
For the three months ended September 30, 2021, we earned $41.4 million before taxes and recorded a benefit from income taxes of $10.4 million resulting in an effective tax rate of (25.2)%. For the nine months ended September 30, 2021, we earned $112.8 million before taxes and recorded a benefit from income taxes of $3.9 million resulting in an effective tax rate of (3.5)%. The effective tax rate varied from the U.S. federal statutory rate for the three months ended September 30, 2021 primarily due to the net impact of foreign operations and the reversal of certain deferred tax liabilities as a result of legal entity restructuring of foreign holding companies. The effective tax rate varied from the U.S. federal statutory rate for the nine months ended September 30, 2021, primarily due to higher withholding taxes related to transactions with and amongst various foreign subsidiaries, offset by the net impact of foreign operations, the reversal of certain deferred tax liabilities as a result of legal entity restructuring of foreign holding companies and favorable resolution of audits in foreign jurisdictions.
As of September 30, 2022, the amount of unrecognized tax benefits increased by $6.5 million from December 31, 2021. With limited exception, we are no longer subject to U.S. federal income tax audits for years through 2017, state and local income tax audits for years through 2015 or non-U.S. income tax audits for years through 2014. We are currently under examination for various years in Canada, China, Germany, India, Indonesia, Italy, Malaysia, Kenya, Madagascar, Mexico, the Philippines, Saudi Arabia, the U.S. and Venezuela.
It is reasonably possible that within the next 12 months the effective tax rate will be impacted by the resolution of some or all of the matters audited by various taxing authorities. It is also reasonably possible that we will have the statute of limitations close in various taxing jurisdictions within the next 12 months. As such, we estimate we could record a reduction in our tax expense of approximately $14 million within the next 12 months.
The Company maintains a full valuation allowance against the net deferred tax assets in certain foreign tax jurisdictions as of September 30, 2022. As of each reporting date, management considers new evidence, both positive and negative, that could affect its view of the future realization of net deferred tax assets. It is possible that within the next 12 months there may be sufficient positive evidence to release a portion or all of the valuation allowance in certain foreign tax jurisdictions. Release of these valuation allowances would result in a benefit to income tax expense for the period the release is recorded, which could have a material impact on net earnings. The timing and amount of the potential valuation allowance release are subject to significant management judgment and the level of profitability achieved.
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14.Segment Information
The following is a summary of the financial information of the reportable segments reconciled to the amounts reported in the condensed consolidated financial statements:
| Three Months Ended September 30, 2022 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Subtotal–Reportable Segments | Eliminations and All Other | Consolidated Total | ||||||||||||||||||||||||
| Sales to external customers | $ | 591,346 | $ | 281,535 | $ | 872,881 | $ | — | $ | 872,881 | |||||||||||||||||||
| Intersegment sales | 1,264 | 1,033 | 2,297 | (2,297) | — | ||||||||||||||||||||||||
| Segment operating income | 38,912 | 29,718 | 68,630 | (44,413) | 24,217 | ||||||||||||||||||||||||
| Three Months Ended September 30, 2021 | |||||||||||||||||||||||||||||
| FPD | FCD | Subtotal–Reportable Segments | Eliminations and All Other | Consolidated Total | |||||||||||||||||||||||||
| Sales to external customers | $ | 601,108 | $ | 265,010 | $ | 866,118 | $ | — | $ | 866,118 | |||||||||||||||||||
| Intersegment sales | 731 | 1,114 | 1,845 | (1,845) | — | ||||||||||||||||||||||||
| Segment operating income | 59,071 | 27,743 | 86,814 | (29,452) | 57,362 | ||||||||||||||||||||||||
| Nine Months Ended September 30, 2022 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Subtotal–Reportable Segments | Eliminations and All Other | Consolidated Total | ||||||||||||||||||||||||
| Sales to external customers | $ | 1,779,758 | $ | 796,403 | $ | 2,576,161 | $ | — | $ | 2,576,161 | |||||||||||||||||||
| Intersegment sales | 3,307 | 2,426 | 5,733 | (5,733) | — | ||||||||||||||||||||||||
| Segment operating income | 117,260 | 75,324 | 192,584 | (100,666) | 91,918 | ||||||||||||||||||||||||
| Nine Months Ended September 30, 2021 | |||||||||||||||||||||||||||||
| FPD | FCD | Subtotal–Reportable Segments | Eliminations and All Other | Consolidated Total | |||||||||||||||||||||||||
| Sales to external customers | $ | 1,820,708 | $ | 800,896 | $ | 2,621,604 | $ | — | $ | 2,621,604 | |||||||||||||||||||
| Intersegment sales | 1,463 | 2,211 | 3,674 | (3,674) | — | ||||||||||||||||||||||||
| Segment operating income | 180,698 | 89,685 | 270,383 | (84,755) | 185,628 | ||||||||||||||||||||||||
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15.Accumulated Other Comprehensive Income (Loss)
The following table presents the changes in AOCL, net of tax for the three months ended September 30, 2022 and 2021:
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||||||||||||||
| (Amounts in thousands) | Foreign currency translation items(1) | Pension and other post-retirement effects | Cash flow hedging activity (2) | Total | Foreign currency translation items(1) | Pension and other post-retirement effects | Cash flow hedging activity (2) | Total | |||||||||||||||||||||||||||||||||||||||
| Balance - July 1 | $ | (536,929) | $ | (91,508) | $ | (1,278) | $ | (629,715) | $ | (453,328) | $ | (140,405) | $ | (271) | $ | (594,004) | |||||||||||||||||||||||||||||||
| Other comprehensive income (loss) before reclassifications (3) | (89,282) | 7,961 | — | (81,321) | (15,561) | 2,300 | — | (13,261) | |||||||||||||||||||||||||||||||||||||||
| Amounts reclassified from AOCL | — | (1,800) | 29 | (1,771) | — | 2,655 | (1,347) | 1,308 | |||||||||||||||||||||||||||||||||||||||
| Net current-period other comprehensive income (loss) (3) | (89,282) | 6,161 | 29 | (83,092) | (15,561) | 4,955 | (1,347) | (11,953) | |||||||||||||||||||||||||||||||||||||||
| Balance - September 30 | $ | (626,211) | $ | (85,347) | $ | (1,249) | $ | (712,807) | $ | (468,889) | $ | (135,450) | $ | (1,618) | $ | (605,957) | |||||||||||||||||||||||||||||||
________________________________
(1) Includes foreign currency translation adjustments attributable to noncontrolling interests of $5.9 million and $6.1 million at July 1, 2022 and 2021, respectively, and $5.8 million and $6.1 million at September 30, 2022 and 2021, respectively. Also includes the impacts from the changes in fair value of our cross-currency swaps, which were $21.3 million and $12.5 million for the three months ended September 30, 2022 and 2021, respectively.
(2) Other comprehensive loss before reclassifications and amounts reclassified from AOCL to interest expense related to designated cash flow hedges.
(3) Amounts in parentheses indicate an increase to AOCL.
The following table presents the reclassifications out of AOCL:
| Three Months Ended September 30, | ||||||||||||||||||||
| (Amounts in thousands) | Affected line item in the statement of income | 2022(1) | 2021(1) | |||||||||||||||||
| Pension and other postretirement effects | ||||||||||||||||||||
| Amortization of actuarial losses(2) | Other income (expense), net | $ | 1,453 | $ | (2,978) | |||||||||||||||
| Prior service costs(2) | Other income (expense), net | 134 | (149) | |||||||||||||||||
| Tax benefit | 213 | 472 | ||||||||||||||||||
| Net of tax | $ | 1,800 | $ | (2,655) | ||||||||||||||||
| Cash flow hedging activity | ||||||||||||||||||||
| Amortization of Treasury rate lock | Interest income (expense) | $ | (38) | $ | 1,761 | |||||||||||||||
| Tax benefit (expense) | 9 | (414) | ||||||||||||||||||
| Net of tax | $ | (29) | $ | 1,347 | ||||||||||||||||
__________________________________
(1) Amounts in parentheses indicate decreases to income. None of the reclassified amounts have a noncontrolling interest component.
(2) These AOCL components are included in the computation of net periodic pension cost. See Note 11 for additional details.
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The following table presents the changes in AOCL, net of tax for the nine months ended September 30, 2022 and 2021:
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||||||||||||||
| (Amounts in thousands) | Foreign currency translation items(1) | Pension and other post-retirement effects | Cash flow hedging activity (2) | Total | Foreign currency translation items(1) | Pension and other post-retirement effects | Cash flow hedging activity (2) | Total | |||||||||||||||||||||||||||||||||||||||
| Balance - January 1 | $ | (456,025) | $ | (101,665) | $ | (1,336) | $ | (559,026) | $ | (456,437) | $ | (146,723) | $ | (488) | $ | (603,648) | |||||||||||||||||||||||||||||||
| Other comprehensive income (loss) before reclassifications (3) | (170,187) | 22,325 | — | (147,862) | (12,452) | 3,104 | — | (9,348) | |||||||||||||||||||||||||||||||||||||||
| Amounts reclassified from AOCL | — | (6,007) | 87 | (5,920) | — | 8,169 | (1,130) | 7,039 | |||||||||||||||||||||||||||||||||||||||
| Net current-period other comprehensive income (loss) (3) | (170,187) | 16,318 | 87 | (153,782) | (12,452) | 11,273 | (1,130) | (2,309) | |||||||||||||||||||||||||||||||||||||||
| Balance - September 30 | $ | (626,212) | $ | (85,347) | $ | (1,249) | $ | (712,808) | $ | (468,889) | $ | (135,450) | $ | (1,618) | $ | (605,957) | |||||||||||||||||||||||||||||||
________________________________
(1) Includes foreign currency translation adjustments attributable to noncontrolling interests of $4.6 million and $5.9 million at January 1, 2022 and 2021, respectively, and $5.8 million and $6.1 million at September 30, 2022 and 2021, respectively. Also includes the impacts from the changes in fair value of our cross-currency swaps, which were $56.3 million and $22.3 million for the nine months ended September 30, 2022 and 2021, respectively.
(2) Other comprehensive loss before reclassifications and amounts reclassified from AOCL to interest expense related to designated cash flow hedges.
(3) Amounts in parentheses indicate an increase to AOCL.
The following table presents the reclassifications out of AOCL:
| Nine Months Ended September 30, | ||||||||||||||||||||
| (Amounts in thousands) | Affected line item in the statement of income | 2022(1) | 2021(1) | |||||||||||||||||
| Pension and other postretirement effects | ||||||||||||||||||||
| Amortization of actuarial losses(2) | Other income (expense), net | $ | 4,653 | $ | (9,126) | |||||||||||||||
| Prior service costs(2) | Other income (expense), net | 429 | (457) | |||||||||||||||||
| Tax benefit | 925 | 1,414 | ||||||||||||||||||
| Net of tax | $ | 6,007 | $ | (8,169) | ||||||||||||||||
| Cash flow hedging activity | ||||||||||||||||||||
| Amortization of Treasury rate lock | Interest income (expense) | $ | (114) | $ | 1,478 | |||||||||||||||
| Tax benefit (expense) | 27 | (348) | ||||||||||||||||||
| Net of tax | $ | (87) | $ | 1,130 | ||||||||||||||||
__________________________________
(1) Amounts in parentheses indicate decreases to income. None of the reclassified amounts have a noncontrolling interest component.
(2) These AOCL components are included in the computation of net periodic pension cost. See Note 11 for additional details.
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16.Realignment Programs
In the second quarter of 2020, we identified and initiated certain realignment activities to right-size our organizational operations based on the current business environment, with the overall objective to reduce our workforce costs, including manufacturing optimization through the consolidation of certain facilities ("Realignment Program"). The realignment activities consist of restructuring and non-restructuring charges. Restructuring charges represent costs associated with the relocation of certain business activities and facility closures and include related severance costs. Non-restructuring charges are primarily employee severance associated with the workforce reductions. Expenses are primarily reported in cost of sales ("COS") or selling, general and administrative ("SG&A"), as applicable, in our consolidated statements of income. We anticipate a total investment in these activities of approximately $95 million and the vast majority of the charges were incurred in 2020 and 2021 with the remainder to be incurred in 2022. There are certain other realignment activities that are currently being evaluated, but have not yet been finalized and therefore are not included in the above anticipated total investment.
Generally, the aforementioned charges will be paid in cash, except for asset write-downs, which are non-cash charges. The following is a summary of total charges, net of adjustments, incurred related to our Realignment Program:
| Three Months Ended September 30, 2022 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Subtotal–Reportable Segments | All Other | Consolidated Total | ||||||||||||||||||||||||
| Realignment Charges | |||||||||||||||||||||||||||||
| Restructuring Charges | |||||||||||||||||||||||||||||
| COS | $ | (456) | $ | 26 | $ | (430) | $ | — | $ | (430) | |||||||||||||||||||
| SG&A | — | 2 | 2 | — | 2 | ||||||||||||||||||||||||
| $ | (456) | $ | 28 | $ | (428) | $ | — | $ | (428) | ||||||||||||||||||||
| Non-Restructuring Charges | |||||||||||||||||||||||||||||
| COS | $ | 39 | $ | (4) | $ | 35 | $ | — | $ | 35 | |||||||||||||||||||
| SG&A | 74 | 5 | 79 | 18 | 97 | ||||||||||||||||||||||||
| $ | 113 | $ | 1 | $ | 114 | $ | 18 | $ | 132 | ||||||||||||||||||||
| Total Realignment Charges | |||||||||||||||||||||||||||||
| COS | $ | (417) | $ | 22 | $ | (395) | $ | — | $ | (395) | |||||||||||||||||||
| SG&A | 74 | 7 | 81 | 18 | 99 | ||||||||||||||||||||||||
| Total | $ | (343) | $ | 29 | $ | (314) | $ | 18 | $ | (296) | |||||||||||||||||||
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| Three Months Ended September 30, 2021 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Subtotal–Reportable Segments | All Other | Consolidated Total | ||||||||||||||||||||||||
| Realignment Charges | |||||||||||||||||||||||||||||
| Restructuring Charges | |||||||||||||||||||||||||||||
| COS | $ | 1,659 | $ | 185 | $ | 1,844 | $ | — | $ | 1,844 | |||||||||||||||||||
| SG&A | 38 | (7) | 31 | — | 31 | ||||||||||||||||||||||||
| $ | 1,697 | $ | 178 | $ | 1,875 | $ | — | $ | 1,875 | ||||||||||||||||||||
| Non-Restructuring Charges | |||||||||||||||||||||||||||||
| COS | $ | 614 | $ | 124 | $ | 738 | $ | — | $ | 738 | |||||||||||||||||||
| SG&A | (290) | 6 | (284) | 621 | 337 | ||||||||||||||||||||||||
| $ | 324 | $ | 130 | $ | 454 | $ | 621 | $ | 1,075 | ||||||||||||||||||||
| Total Realignment Charges | |||||||||||||||||||||||||||||
| COS | $ | 2,273 | $ | 309 | $ | 2,582 | $ | — | $ | 2,582 | |||||||||||||||||||
| SG&A | (252) | (1) | (253) | 621 | 368 | ||||||||||||||||||||||||
| Total | $ | 2,021 | $ | 308 | $ | 2,329 | $ | 621 | $ | 2,950 | |||||||||||||||||||
| Nine Months Ended September 30, 2022 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Subtotal–Reportable Segments | All Other | Consolidated Total | ||||||||||||||||||||||||
| Realignment Charges | |||||||||||||||||||||||||||||
| Restructuring Charges | |||||||||||||||||||||||||||||
| COS | $ | 430 | $ | 97 | $ | 527 | $ | — | $ | 527 | |||||||||||||||||||
| SG&A | — | 2 | 2 | — | 2 | ||||||||||||||||||||||||
| $ | 430 | $ | 99 | $ | 529 | $ | — | $ | 529 | ||||||||||||||||||||
| Non-Restructuring Charges | |||||||||||||||||||||||||||||
| COS | $ | (550) | $ | (41) | $ | (591) | $ | (61) | $ | (652) | |||||||||||||||||||
| SG&A | 150 | 55 | 205 | (248) | (43) | ||||||||||||||||||||||||
| $ | (400) | $ | 14 | $ | (386) | $ | (309) | $ | (695) | ||||||||||||||||||||
| Total Realignment Charges | |||||||||||||||||||||||||||||
| COS | $ | (120) | $ | 56 | $ | (64) | $ | (61) | $ | (125) | |||||||||||||||||||
| SG&A | 150 | 57 | 207 | (248) | (41) | ||||||||||||||||||||||||
| Total | $ | 30 | $ | 113 | $ | 143 | $ | (309) | $ | (166) | |||||||||||||||||||
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| Nine Months Ended September 30, 2021 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Subtotal–Reportable Segments | All Other | Consolidated Total | ||||||||||||||||||||||||
| Realignment Charges | |||||||||||||||||||||||||||||
| Restructuring Charges | |||||||||||||||||||||||||||||
| COS | $ | 7,702 | $ | 655 | $ | 8,357 | $ | — | $ | 8,357 | |||||||||||||||||||
| SG&A | 705 | (17) | 688 | — | 688 | ||||||||||||||||||||||||
| $ | 8,407 | $ | 638 | $ | 9,045 | $ | — | $ | 9,045 | ||||||||||||||||||||
| Non-Restructuring Charges | |||||||||||||||||||||||||||||
| COS | $ | 6,064 | $ | 802 | $ | 6,866 | $ | 590 | $ | 7,456 | |||||||||||||||||||
| SG&A | 205 | 744 | 949 | 4,816 | 5,765 | ||||||||||||||||||||||||
| $ | 6,269 | $ | 1,546 | $ | 7,815 | $ | 5,406 | $ | 13,221 | ||||||||||||||||||||
| Total Realignment Charges | |||||||||||||||||||||||||||||
| COS | $ | 13,766 | $ | 1,457 | $ | 15,223 | $ | 590 | $ | 15,813 | |||||||||||||||||||
| SG&A | 910 | 727 | 1,637 | 4,816 | 6,453 | ||||||||||||||||||||||||
| Total | $ | 14,676 | $ | 2,184 | $ | 16,860 | $ | 5,406 | $ | 22,266 | |||||||||||||||||||
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The following is a summary of total inception to date charges, net of adjustments, related to the Realignment Program:
| Inception to Date | |||||||||||||||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Subtotal–Reportable Segments | All Other | Consolidated Total | ||||||||||||||||||||||||
| Realignment Charges | |||||||||||||||||||||||||||||
| Restructuring Charges | |||||||||||||||||||||||||||||
| COS | $ | 26,306 | $ | 2,133 | $ | 28,439 | $ | — | $ | 28,439 | |||||||||||||||||||
| SG&A | 716 | 335 | 1,051 | (17) | 1,034 | ||||||||||||||||||||||||
| $ | 27,022 | $ | 2,468 | $ | 29,490 | $ | (17) | $ | 29,473 | ||||||||||||||||||||
| Non-Restructuring Charges | |||||||||||||||||||||||||||||
| COS | $ | 24,858 | $ | 681 | $ | 25,539 | $ | 581 | $ | 26,120 | |||||||||||||||||||
| SG&A | 11,199 | 5,317 | 16,516 | 21,547 | 38,063 | ||||||||||||||||||||||||
| $ | 36,057 | $ | 5,998 | $ | 42,055 | $ | 22,128 | $ | 64,183 | ||||||||||||||||||||
| Total Realignment Charges | |||||||||||||||||||||||||||||
| COS | $ | 51,164 | $ | 2,814 | $ | 53,978 | $ | 581 | $ | 54,559 | |||||||||||||||||||
| SG&A | 11,915 | 5,652 | 17,567 | 21,530 | 39,097 | ||||||||||||||||||||||||
| Total | $ | 63,079 | $ | 8,466 | $ | 71,545 | $ | 22,111 | $ | 93,656 | |||||||||||||||||||
Restructuring charges represent costs associated with the relocation or reorganization of certain business activities and facility closures and include costs related to employee severance at closed facilities, contract termination costs, asset write-downs and other costs. Severance costs primarily include costs associated with involuntary termination benefits. Contract termination costs include costs related to the termination of operating leases or other contract termination costs. Asset write-downs include accelerated depreciation of fixed assets, accelerated amortization of intangible assets, divestiture of certain non-strategic assets and inventory write-downs. Other costs generally include costs related to employee relocation, asset relocation, vacant facility costs (i.e., taxes and insurance) and other charges.
The following is a summary of restructuring charges, net of adjustments, for our restructuring activities related to our Realignment Program:
| Three Months Ended September 30, 2022 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | Severance | Contract Termination | Asset Write-Downs | Other | Total | ||||||||||||||||||||||||
| COS | $ | (309) | $ | — | $ | (89) | $ | (32) | $ | (430) | |||||||||||||||||||
| SG&A | 12 | — | — | (10) | 2 | ||||||||||||||||||||||||
| Total | $ | (297) | $ | — | $ | (89) | $ | (42) | $ | (428) | |||||||||||||||||||
| Three Months Ended September 30, 2021 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | Severance | Contract Termination | Asset Write-Downs | Other | Total | ||||||||||||||||||||||||
| COS | $ | (371) | $ | — | $ | 1,282 | $ | 933 | $ | 1,844 | |||||||||||||||||||
| SG&A | — | — | — | 31 | 31 | ||||||||||||||||||||||||
| Total | $ | (371) | $ | — | $ | 1,282 | $ | 964 | $ | 1,875 | |||||||||||||||||||
| Nine Months Ended September 30, 2022 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | Severance | Contract Termination | Asset Write-Downs | Other | Total | ||||||||||||||||||||||||
| COS | $ | 260 | $ | — | $ | 170 | $ | 97 | $ | 527 | |||||||||||||||||||
| SG&A | 12 | — | — | (10) | 2 | ||||||||||||||||||||||||
| Total | $ | 272 | $ | — | $ | 170 | $ | 87 | $ | 529 | |||||||||||||||||||
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| Nine Months Ended September 30, 2021 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | Severance | Contract Termination | Asset Write-Downs | Other | Total | ||||||||||||||||||||||||
| COS | $ | 848 | $ | — | $ | 2,623 | $ | 4,886 | $ | 8,357 | |||||||||||||||||||
| SG&A | 168 | — | — | 520 | 688 | ||||||||||||||||||||||||
| Total | $ | 1,016 | $ | — | $ | 2,623 | $ | 5,406 | $ | 9,045 | |||||||||||||||||||
The following is a summary of total inception to date restructuring charges, net of adjustments, related to our Realignment Program:
| Inception to Date | |||||||||||||||||||||||||||||
| (Amounts in thousands) | Severance | Contract Termination | Asset Write-Downs | Other | Total | ||||||||||||||||||||||||
| COS | $ | 16,464 | $ | 86 | $ | 4,265 | $ | 7,624 | $ | 28,439 | |||||||||||||||||||
| SG&A | 263 | — | 14 | 757 | 1,034 | ||||||||||||||||||||||||
| Total | $ | 16,727 | $ | 86 | $ | 4,279 | $ | 8,381 | $ | 29,473 | |||||||||||||||||||
The following represents the activity, primarily severance charges from reductions in force, related to the restructuring reserves for the nine months ended September 30, 2022 and 2021:
| (Amounts in thousands) | 2022 | 2021 | |||||||||
| Balance at January 1 | $ | 4,868 | $ | 18,255 | |||||||
| Charges, net of adjustments | 359 | 6,423 | |||||||||
| Cash expenditures | (2,311) | (16,999) | |||||||||
| Other non-cash adjustments, including currency | (1,431) | (1,039) | |||||||||
| Balance at September 30 | $ | 1,485 | $ | 6,640 | |||||||
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and notes thereto, and the other financial data included elsewhere in this Quarterly Report. The following discussion should also be read in conjunction with our audited consolidated financial statements, and notes thereto, and "Management’s Discussion and Analysis of Financial Condition and Results of Operations" ("MD&A") included in our 2021 Annual Report.
EXECUTIVE OVERVIEW
Our Company
We are a world-leading manufacturer and aftermarket service provider of comprehensive flow control systems. We develop and manufacture precision-engineered flow control equipment integral to the movement, control and protection of the flow of materials in our customers’ critical processes. Our product portfolio of pumps, valves, seals, automation and aftermarket services supports global infrastructure industries, including oil and gas, chemical, power generation and water management, as well as general industrial markets where our products and services add value. Through our manufacturing platform and global network of Quick Response Centers ("QRCs"), we offer a broad array of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting. We currently employ approximately 15,000 employees in more than 50 countries.
Our business model is significantly influenced by the capital and operating spending of global infrastructure industries for the placement of new products into service and aftermarket services for existing operations. The worldwide installed base of our products is an important source of aftermarket revenue, where products are relied upon to maximize operating time of many key industrial processes. We continue to invest significantly in our aftermarket strategy to provide local support to drive customer investments in our offerings and use of our services to replace or repair installed products. The aftermarket portion of our business also helps provide business stability during various economic periods. The aftermarket service and solutions business, which is primarily served by our network of 156 QRCs located around the globe, provides a variety of service offerings for our
26
customers including spare parts, service solutions, product life cycle solutions and other value-added services. It is generally a higher margin business compared to our original equipment business and a key component of our business strategy.
Our operations are conducted through two business segments that are referenced throughout this MD&A:
•FPD designs and manufactures custom, highly-engineered pumps, pre-configured industrial pumps, pump systems, mechanical seals, auxiliary systems and replacement parts and related services; and
•FCD designs, manufactures and distributes a broad portfolio of engineered-to-order and configured-to-order isolation valves, control valves, valve automation products and related equipment.
Our business segments share a focus on industrial flow control technology and have a number of common customers. These segments also have complementary product offerings and technologies that are often combined in applications that provide us a net competitive advantage. Our segments also benefit from our global footprint and our economies of scale in reducing administrative and overhead costs to serve customers more cost effectively. For example, our segments share leadership for operational support functions, such as sales, research and development, marketing and supply chain.
The reputation of our product portfolio is built on more than 50 well-respected brand names such as Worthington, IDP, Valtek, Limitorque, Durco, Argus, Edward, Valbart and Durametallic, which we believe to be one of the most comprehensive in the industry. Our products and services are sold either directly or through designated channels to more than 10,000 companies, including some of the world’s leading engineering, procurement and construction ("EPC") firms, original equipment manufacturers, distributors and end users.
We continue to leverage our QRC network to be positioned as near to customers as possible for service and support in order to capture valuable aftermarket business. Along with maintaining the local capability to sell, install and service our equipment in remote regions, it is equally imperative to continuously improve our global operations. Despite headwinds caused by the COVID-19 pandemic, we continue to enhance our global supply chain capabilities to increase our ability to meet global customer demands and improve the quality and timely delivery of our products over the long-term. Additionally, we continue to devote resources to improve the supply chain processes across our business segments and find areas of synergy and cost reduction, all along improving our supply chain management capability to meet global customer demands. We also remain focused on improving on-time delivery and quality, while managing warranty costs as a percentage of sales across our global operations, through the assistance of a focused Continuous Improvement Process ("CIP") initiative. The goal of the CIP initiative, which includes lean manufacturing, six sigma business management strategy and value engineering, is to maximize service fulfillment to customers through on-time delivery, reduced cycle time and quality at the highest internal productivity.
COVID-19 Update
We continue to assess and proactively respond to the impacts of the COVID-19 pandemic on all aspects of our business and geographies, including with respect to our associates, customers and communities, supply chain impacts and labor availability issues, and to take appropriate actions in an effort to mitigate adverse effects of the pandemic.
We are adhering to the state and country mandates and guidelines related to the COVID-19 pandemic wherever we operate. The substantial majority of our production sites have remained fully operational this year, while also protecting the health and safety of our associates.
While we cannot reasonably estimate with certainty the duration and severity of the COVID-19 pandemic or its ultimate impact on the global economy, our business or our financial condition and results, we nonetheless remain committed to providing the critical support, products and services that our customers rely on, and currently believe that we will emerge from these events well positioned for long-term growth.
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Health and Safety
The health and safety of our associates, suppliers and customers around the world continues to be a priority as we navigate the COVID-19 pandemic, including the effect and duration of variant strains of the virus in the various geographies in which we operate. As a result of the emergence of these variants, certain geographies where we operate, such as China, have occasionally reinstituted temporary government-mandated shutdowns that were previously implemented to curtail the spread of the virus. While all of our facilities generally remain open and operational, the measures described above, combined with continued employee costs and under-absorption of manufacturing costs as a result of temporary closures and work-from-home policies, have had and are expected to continue having an adverse impact on our financial performance throughout the remainder of the pandemic. Despite the increased challenges of labor availability through the third quarter of 2022, we continue to expect a decline of these adverse impacts as we navigate through the remainder of 2022. Our associates continue to demonstrate strong resilience in adapting to continually evolving health and safety guidelines while still providing products and services to our customers during this challenging time.
Supply Chain Impact
Since the onset of the pandemic, many of our suppliers have also experienced varying lengths of production and shipping delays related to the COVID-19 pandemic and its effects, some of which continue to exist in highly affected countries. For example, as part of its COVID-related policies, China has declared a number of city-wide lockdowns that have, and may continue to, adversely affected the global supply chain. As a result of these measures, our production facilities and suppliers located in China have experienced, and may continue to experience, interruptions in production. These interruptions have contributed to component shortages and other supply chain constraints that may limit our ability to fulfill customer orders within desired lead times, both directly in the Asia Pacific Region and indirectly in other regions.
Additionally, the global supply chain and logistics constraints that have been affecting global markets since the third quarter of 2021 have continued to cause additional headwinds through the first nine months of 2022. These conditions have had an adverse effect on the speed at which we can manufacture and ship our products to customers, and have also led to an increase in logistics, transportation and freight costs, requiring that we diversify our supply chain and, in some instances, source materials from new suppliers. Additionally, these conditions have in some cases impacted our ability to deliver products to customers on time, which has in turn led to an increase in backlog at some of our manufacturing sites. These disruptions in our supply chain and their effects have continued and we expect they will continue as ongoing global supply chain and logistics headwinds continue.
In order to position ourselves to fulfill demand and to counteract the ongoing impacts on our supply chain, we continue to monitor the supply chain closely and to take various proactive steps to protect the continuity of supply, including building inventory to support backlog execution, qualifying alternative sources and redesigning our products.
Operational Impacts
We have engaged in a number of cost savings measures in order to help mitigate certain of the adverse effects of the COVID-19 pandemic on our financial results, including certain realignment activities (further described below under “RESULTS OF OPERATIONS – Nine months ended September 30, 2022 and 2021”), reductions in capital expenditures and continued cuts in other discretionary spending due to our response to the global macroeconomic effects of COVID-19, which partially offsets the continued costs and operational impacts of the safety protocols and procedures that we have implemented and sustained as described above under the heading "Health and Safety" and resulting inflationary pressures. We continue to evaluate additional cost savings measures in order to reduce the impact of the COVID-19 pandemic on our financial results, and we will continue to adapt our operations to respond to the changing conditions as needed.
In connection with the supply chain disruptions described above under the heading “Supply Chain Impact,” we have also experienced, and continue to experience, increased inflation and higher freight and logistics costs. In response to these increased costs, we are engaging in various mitigation strategies, including enhanced price realization efforts.
During the first three quarters of 2022, we continued to experience the same increased difficulty in maintaining staffing and productivity levels due to both a higher quarantine rate and a tighter labor market for new hiring as we experienced in the first three quarters of 2021. As we continue to manage our business through this time of uncertainty and market volatility, we will remain focused on the health and safety of our associates, suppliers, customers, and will continue to provide essential products and services to our customers.
Customer Demand
During the first nine months of 2022, the ongoing effects of the COVID-19 pandemic in global markets have continued to adversely impact our customers, particularly in the oil and gas markets. As a result of the pandemic’s effect (among certain other effects) on oil prices during 2020, many of our large oil and gas customers reduced capital expenditures and budgets in 2020. To date, while spending for maintenance and repair projects and aftermarket services have returned to pre-pandemic
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levels over the past several quarters, project-based, oil and gas customer spending has yet to return to pre-pandemic levels despite some meaningful improvement in the first nine months of 2022. In this regard, we saw an overall increase in bookings of 19.3% in the first nine months of 2022 as compared to the same period in 2021. Despite the meaningful improvement in customer spending, during the first nine months of 2022 we continued to experience supply chain disruptions as described above under the heading "Supply Chain Impact" as well as customer-driven delays in the witnessing and inspection necessary to take delivery of equipment.
While many of the repair and maintenance projects that were paused by our customers in 2020 as a result of the pandemic were completed in 2021, repair and maintenance delays continued in 2021 and the first nine months of 2022. The timing for completion of such delayed projects will largely depend on the duration of the COVID-19 pandemic and how the virus continues to spread in our customers’ various geographies, as the pandemic continues to impact demand, utilization and required maintenance. While we saw some recovery in oil and gas capital expenditure budgets in the first nine months of 2022, capital spending has yet to reach pre-pandemic levels. We continue to expect planned oil and gas capital spending to increase through the rest of 2022 but remain below pre-pandemic levels.
Impact of Russia-Ukraine Conflict on our Business
In response to the ongoing military conflict in Ukraine, several countries, including the United States, have imposed economic sanctions and export controls on certain industry sectors and parties in Russia. As a result of this conflict, including the aforementioned sanctions and overall instability in the region, in February 2022 we stopped accepting new orders in Russia and temporarily suspended fulfillment of existing orders. In March 2022, we made the decision to permanently cease all Company operations in Russia. We have commenced the necessary actions to cease operations of our Russian subsidiary, including taking steps to cancel existing contracts with customers, terminate our approximately 50 Russia-based employees and terminate other related contractual commitments, and currently expect this process to be substantially complete by the end of 2022. As a result of the conflict and the resulting macroeconomic impacts we have also experienced supply shortages and inflationary pressures.
In 2021 our Russian subsidiary had approximately $14 million of sales with an additional $36 million of sales from certain of our other foreign subsidiaries into the Russian market. As of March 31, 2022, the net assets held on our Russian subsidiary's balance sheet were $2.7 million, including $7.1 million of cash, $3.6 million of accounts receivables, net, a $9.3 million net intercompany payable position and other immaterial amounts. In addition, certain of our other foreign subsidiaries had open contracts with Russian customers that were subsequently cancelled for which revenue had been previously recognized over time utilizing the percentage of completion ("POC") method. As a result of the above, in the first quarter of 2022 we recorded a $20.2 million pre-tax charge ($21.0 million after-tax) to reserve the asset positions of our Russian subsidiary (excluding cash) as of March 31, 2022, to record contra-revenue for previously recognized revenue and estimated cancellation fees on open contracts that were previously accounted for under POC and subsequently canceled, to establish a reserve for the estimated cost to exit the operations of our Russian subsidiary and to record a reserve for our estimated financial exposure on contracts that have or are anticipated to be cancelled. We reevaluated our financial exposure as of June 30, 2022 and September 30, 2022, and concluded that the reserve recorded as of March 31, 2022 is sufficient and no material changes to reserves were needed.
The following table presents the above impacts of the Russia pre-tax charge:
| Nine Months Ended September 30, 2022 | |||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Consolidated Total | ||||||||||||||
| Sales | $ | (5,429) | $ | (2) | $ | (5,431) | |||||||||||
| Cost of sales ("COS") | 3,510 | 1,112 | 4,622 | ||||||||||||||
| Gross loss | (8,939) | (1,114) | (10,053) | ||||||||||||||
| Selling, general and administrative expense ("SG&A") | 9,111 | 1,082 | 10,193 | ||||||||||||||
| Operating loss | $ | (18,050) | $ | (2,196) | $ | (20,246) | |||||||||||
We continue to monitor the situation involving Russia and Ukraine and its impact on the rest of our global business. This includes the macroeconomic impact, including with respect to global supply chain issues and inflationary pressures. To date, these impacts have not been material to our business and we do not currently expect that any incremental impact in future quarters, including any financial impacts caused by our cancellation of customer contracts and ceasing of operations in Russia, will be material to the Company.
2022 Outlook
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As the world continues to make progress against COVID-19 largely through increased vaccinations, we have seen an inflection in our served end-markets as commodity prices and mobility levels increase. With our increased backlog and improved market environment we expect to return to growth in 2022, however the combined effects of the supply chain, logistics and labor availability headwinds have continued into the first nine months of 2022. Further, we have not seen and do not expect to see an increase in cancellations from our backlog. We therefore expect to continue to deliver on our backlog during 2022, though with a slightly longer cycle time than originally expected.
As of September 30, 2022, we have cash and cash equivalents of $351.9 million and $157.3 million of borrowings available under our Senior Credit Facility. We do not currently anticipate, nor are we aware of, any significant market conditions or commitments that would change any of our conclusions of the liquidity currently available to us. Additionally, we expect that the costs savings measures planned and already in place will enable us to maintain adequate liquidity over the short-term (next 12 months) and long-term (beyond the next 12 months) as we manage through the current market environment. We will continue to actively monitor the potential impacts of COVID-19 and related events on the credit markets in order to maintain sufficient liquidity and access to capital.
RESULTS OF OPERATIONS — Three and nine months ended September 30, 2022 and 2021
Throughout this discussion of our results of operations, we discuss the impact of fluctuations in foreign currency exchange rates. We have calculated currency effects on operations by translating current year results on a monthly basis at prior year exchange rates for the same periods.
In the second quarter of 2020, we identified and initiated certain realignment activities to right-size our organizational operations based on the current business environment, with the overall objective to reduce our workforce costs. We anticipate a total investment in Realignment Program activities of approximately $95 million and the vast majority of the charges were incurred in 2020 and 2021 with the remainder to be incurred in 2022. There are certain other realignment activities that are currently being evaluated, but have not yet been finalized and therefore are not included in the above anticipated total investment.
Realignment Activity
The following tables present out realignment activity by segment related to our Realignment Program:
| Three Months Ended September 30, 2022 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Subtotal–Reportable Segments | Eliminations and All Other | Consolidated Total | ||||||||||||||||||||||||
| Total Realignment Charges | |||||||||||||||||||||||||||||
| COS | $ | (417) | $ | 22 | $ | (395) | $ | — | $ | (395) | |||||||||||||||||||
| SG&A | 74 | 7 | 81 | 18 | 99 | ||||||||||||||||||||||||
| Total | $ | (343) | $ | 29 | $ | (314) | $ | 18 | $ | (296) | |||||||||||||||||||
| Three Months Ended September 30, 2021 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Subtotal–Reportable Segments | Eliminations and All Other | Consolidated Total | ||||||||||||||||||||||||
| Total Realignment Charges | |||||||||||||||||||||||||||||
| COS | $ | 2,273 | $ | 309 | $ | 2,582 | $ | — | $ | 2,582 | |||||||||||||||||||
| SG&A | (252) | $ | (1) | (253) | 621 | 368 | |||||||||||||||||||||||
| Total | $ | 2,021 | $ | 308 | $ | 2,329 | $ | 621 | $ | 2,950 | |||||||||||||||||||
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| Nine Months Ended September 30, 2022 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Subtotal–Reportable Segments | Eliminations and All Other | Consolidated Total | ||||||||||||||||||||||||
| Total Realignment Charges | |||||||||||||||||||||||||||||
| COS | $ | (120) | $ | 56 | $ | (64) | $ | (61) | $ | (125) | |||||||||||||||||||
| SG&A | 150 | 57 | 207 | (248) | (41) | ||||||||||||||||||||||||
| Total | $ | 30 | $ | 113 | $ | 143 | $ | (309) | $ | (166) | |||||||||||||||||||
| Nine Months Ended September 30, 2021 | |||||||||||||||||||||||||||||
| (Amounts in thousands) | FPD | FCD | Subtotal–Reportable Segments | Eliminations and All Other | Consolidated Total | ||||||||||||||||||||||||
| Total Realignment Charges | |||||||||||||||||||||||||||||
| COS | $ | 13,766 | $ | 1,457 | $ | 15,223 | $ | 590 | $ | 15,813 | |||||||||||||||||||
| SG&A | 910 | 727 | 1,637 | 4,816 | 6,453 | ||||||||||||||||||||||||
| Total | $ | 14,676 | $ | 2,184 | $ | 16,860 | $ | 5,406 | $ | 22,266 | |||||||||||||||||||
Consolidated Results
Bookings, Sales and Backlog
| Three Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Bookings | $ | 1,223.3 | $ | 911.6 | |||||||
| Sales | 872.9 | 866.1 | |||||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Bookings | $ | 3,346.7 | $ | 2,805.7 | |||||||
| Sales | 2,576.2 | 2,621.6 | |||||||||
We define a booking as the receipt of a customer order that contractually engages us to perform activities on behalf of our customer with regard to manufacturing, service or support. Bookings recorded and subsequently canceled within the year-to-date period are excluded from year-to-date bookings. Bookings for the three months ended September 30, 2022 increased by $311.7 million, or 34.2%, as compared with the same period in 2021. The increase included negative currency effects of approximately $60 million. The increase was driven by increased customer orders in the oil and gas, chemical, general and power generation industries. The increase in customer bookings was more heavily weighted towards original equipment bookings. The increase included the impact of FPD original equipment orders booked in the third quarter of 2022 in excess of $210 million to supply pumps and related equipment to support the development of an onshore unconventional gas project in the Middle East.
Bookings for the nine months ended September 30, 2022 increased by $541.0 million, or 19.3%, as compared with the same period in 2021. The increase included negative currency effects of approximately $133 million. The increase was driven by increased customer bookings in the and oil and gas, chemical, general, water management and power generation industries. The increase in customer bookings was more heavily weighted towards original equipment bookings. The increase included the impact of FPD original equipment orders booked in 2022 in excess of $230 million to supply pumps and related equipment to support the development of an onshore unconventional gas project in the Middle East.
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Sales for the three months ended September 30, 2022 increased by $6.8 million, or 0.8%, as compared with the same period in 2021. The increase included negative currency effects of approximately $55 million. The increased sales were driven by aftermarket, with increased sales into North America, Africa and Middle East, partially offset by decreased sales into Europe, Latin America and Asia Pacific. In the third quarter of 2022 we experienced operational interruptions related to the implementation of a new enterprise resource planning system at certain of our North America quick response centers. We estimate that this disruption negatively impacted sales volumes during the period by approximately $30 million and we anticipate to largely recover the sales in future periods. Net sales to international customers, including export sales from the U.S., were approximately 62% and 67% of total sales for the three months ended September 30, 2022 and 2021, respectively.
Sales for the nine months ended September 30, 2022 decreased by $45.4 million, or 1.7%, as compared with the same period in 2021. The decrease included negative currency effects of approximately $116 million. The decreased sales were driven by original equipment, with decreased sales into Europe, Asia Pacific and Latin America, partially offset by increased sales into North America, Africa and the Middle East. Net sales to international customers, including export sales from the U.S., were approximately 62% and 67% of total sales for the three months ended September 30, 2022 and 2021, respectively.
Backlog represents the aggregate value of booked but uncompleted customer orders and is influenced primarily by bookings, sales, cancellations and currency effects. Backlog of $2,601.9 million at September 30, 2022 increased by $598.3 million, or 29.9%, as compared with December 31, 2021 and include the negative impact of $25.2 million of order cancellations in the first quarter of 2022 due to our exposure in Russia. Currency effects provided a decrease of approximately $139 million. Approximately 35% and 38% of the backlog at September 30, 2022 and December 31, 2021, respectively, was related to aftermarket orders. Backlog includes our unsatisfied (or partially unsatisfied) performance obligations related to contracts having an original expected duration in excess of one year of approximately $597 million, as discussed in Note 2 to our condensed consolidated financial statements included in this Quarterly Report.
Gross Profit and Gross Profit Margin
| Three Months Ended September 30, | |||||||||||
| (Amounts in millions, except percentages) | 2022 | 2021 | |||||||||
| Gross profit | $ | 239.6 | $ | 253.5 | |||||||
| Gross profit margin | 27.4 | % | 29.3 | % | |||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions, except percentages) | 2022 | 2021 | |||||||||
| Gross profit | $ | 699.1 | $ | 782.6 | |||||||
| Gross profit margin | 27.1 | % | 29.9 | % | |||||||
Gross profit for the three months ended September 30, 2022 decreased by $13.9 million, or 5.5%, as compared with the same period in 2021. Gross profit margin for the three months ended September 30, 2022 of 27.4% decreased from 29.3% for the same period in 2021. The decrease in gross profit margin was primarily due to the under absorption of $5.1 million of fixed manufacturing costs primarily due to operational interruptions related to the implementation of a new enterprise resource planning system at certain of our North America quick response centers, increased freight costs largely due to global supply chain and logistics constraints and the establishment of $1.7 million of inventory reserves related to certain contracts that are estimated to be below market, partially offset by a mix shift to higher aftermarket sales, decreased costs related to our realignment actions and lower broad-based annual incentive compensation as compared to the same period in 2021. Aftermarket sales represented approximately 53% of total sales for the three months ended September 30, 2022, as compared with approximately 51% of total sales for the same period in 2021.
Gross profit for the nine months ended September 30, 2022 decreased by $83.5 million, or 10.7%, as compared with the same period in 2021. Gross profit margin for the nine months ended September 30, 2022 of 27.1% decreased from 29.9% for the same period in 2021. The decrease in gross profit margin was primarily due to lower conversion of customer backlog to revenue and the under absorption of $5.1 million of fixed manufacturing costs primarily due to operational interruptions related to the implementation of a new enterprise resource planning system at certain of our North America quick response centers, increased freight costs largely due to global supply chain and logistics constraints and a $4.6 million charge taken in the first quarter of 2022 related to our financial exposure in Russia, partially offset by a mix shift to higher aftermarket sales, decreased costs related to our realignment actions and lower broad-based annual incentive compensation as compared to the same period
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in 2021. Aftermarket sales represented approximately 53% of total sales for the nine months ended September 30, 2022, as compared with approximately 52% of total sales for the same period in 2021.
Selling, General and Administrative Expense
| Three Months Ended September 30, | |||||||||||
| (Amounts in millions, except percentages) | 2022 | 2021 | |||||||||
| SG&A | $ | 221.1 | $ | 200.9 | |||||||
| SG&A as a percentage of sales | 25.3 | % | 23.2 | % | |||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions, except percentages) | 2022 | 2021 | |||||||||
| SG&A | $ | 622.0 | $ | 610.0 | |||||||
| SG&A as a percentage of sales | 24.1 | % | 23.3 | % | |||||||
SG&A for the three months ended September 30, 2022 increased by $20.2 million, or 10.1%, as compared with the same period in 2021. Currency effects yielded a decrease of approximately $10 million. SG&A as a percentage of sales for the three months ended September 30, 2022 increased 210 basis points primarily due to increased asbestos-related costs of $3.8 million driven by a $7.8 million adjustment for Incurred But Not Reported ("IBNR") asbestos liability accruals based on an annual actuarial study, the acquisition and expense of $4.8 million of in-process research and development, increased bad debt expense and incremental operating lease expense of $5.5 million related to the identification and correction of an accounting error, partially offset by lower broad-based annual incentive compensation as compared with the same period in 2021.
SG&A for the nine months ended September 30, 2022 increased by $12.0 million, or 2.0%, as compared with the same period in 2021. Currency effects yielded a decrease of approximately $23 million. SG&A as a percentage of sales for the nine months ended September 30, 2022 increased 80 basis points primarily due to a $10.2 million charge taken in the first quarter of 2022 related to our financial exposure in Russia, increased asbestos-related costs of $2.9 million driven by a $7.8 million adjustment in the third quarter of 2022 for IBNR asbestos liability accruals based on an annual actuarial study, incremental operating lease expense of $5.5 million related to the identification and correction of an accounting error, the acquisition and expense of $4.8 million of in-process research and development in the third quarter of 2022 and increased bad debt expense, partially offset by lower costs related to our realignment actions and lower broad-based annual incentive compensation as compared with the same period in 2021.
Net Earnings from Affiliates
| Three Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Net earnings from affiliates | $ | 5.8 | $ | 4.7 | |||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Net earnings from affiliates | $ | 14.8 | $ | 11.2 | |||||||
Net earnings from affiliates for the three months ended September 30, 2022 increased by $1.1 million, or 23.4%, as compared with the same period in 2021. The increase in net earnings was primarily a result of losses in the third quarter of 2021 associated with our FPD joint venture in China that did not recur.
Net earnings from affiliates for the nine months ended September 30, 2022 increased by $3.6 million, or 32.1%, as compared with the same period in 2021. The increase was primarily a result of increased earnings of our FPD joint venture in South Korea.
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Operating Income and Operating Margin
| Three Months Ended September 30, | |||||||||||
| (Amounts in millions, except percentages) | 2022 | 2021 | |||||||||
| Operating income | $ | 24.2 | $ | 57.4 | |||||||
| Operating income as a percentage of sales | 2.8 | % | 6.6 | % | |||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions, except percentages) | 2022 | 2021 | |||||||||
| Operating income | $ | 91.9 | $ | 185.6 | |||||||
| Operating income as a percentage of sales | 3.6 | % | 7.1 | % | |||||||
Operating income for the three months ended September 30, 2022 decreased by $33.2 million, or 57.8%, as compared with the same period in 2021. The decrease included negative currency effects of approximately $5 million. The decrease was primarily a result of the $13.9 million decrease in gross profit and the $20.2 million increase in SG&A.
Operating income for the nine months ended September 30, 2022 decreased by $93.7 million, or 50.5%, as compared with the same period in 2021. The decrease included negative currency effects of approximately $7 million. The decrease was primarily a result of the $83.5 million decrease in gross profit and the $12.0 million increase in SG&A.
Interest Expense and Interest Income
| Three Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Interest expense | $ | (11.6) | $ | (14.7) | |||||||
| Interest income | 1.1 | 0.8 | |||||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Interest expense | $ | (33.3) | $ | (45.8) | |||||||
| Interest income | 2.9 | 1.9 | |||||||||
Interest expense for the three months ended September 30, 2022 decreased $3.1 million, as compared with the same period in 2021, primarily due to lower effective interest rates on our outstanding debt as compared with the same period in 2021.
Interest expense for the nine months ended September 30, 2022 decreased $12.5 million, as compared with the same period in 2021, primarily due to lower effective interest rates on our outstanding debt as compared with the same period in 2021.
Loss on Extinguishment of Debt
| Three Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Loss on extinguishment of debt | $ | — | $ | (0.6) | |||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Loss on extinguishment of debt | $ | — | $ | (8.2) | |||||||
Loss on extinguishment of debt for the three months ended September 30, 2021 of $0.6 million resulted from the write-off of deferred financing fees due to the amendment and restatement of the previous Senior Credit facility in the third quarter of 2021.
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Loss on extinguishment of debt for the nine months ended September 30, 2021 of $8.2 million resulted from the loss on early extinguishment of our 2022 Euro Senior Notes in the first quarter of 2021 and the write-off of deferred financing fees due to the amendment and restatement of the previous Senior Credit facility in the third quarter of 2021.
Other Income (Expense), Net
| Three Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Other income (expense), net | $ | 28.7 | $ | (1.5) | |||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Other income (expense), net | $ | 28.2 | $ | (20.7) | |||||||
Other income, net for the three months ended September 30, 2022 increased $30.2 million as compared with the same period in 2021, due primarily to a $30.2 million increase in gains from transactions in currencies other than our sites' functional currencies and a $1.3 million increase in gains arising from transactions on foreign exchange forward contracts. The net change was primarily due to the foreign currency exchange rate movements in the Euro, Hungarian forint, British pound and Emirati dirham during the three months ended September 30, 2022, as compared with the same period in 2021. Included in the other income, net increase for the period is a $23.6 million foreign currency remeasurement gain associated with a Canadian dollar denominated intercompany loan held by a Euro functional currency entity.
Other income, net for the nine months ended September 30, 2022 increased $48.9 million as compared with the same period in 2021, due primarily to a $49.9 million increase in gains from transactions in currencies other than our sites' functional currencies, partially offset by a $0.2 million decrease in gains arising from transactions on foreign exchange forward contracts. The net change was primarily due to the foreign currency exchange rate movements in the Euro, Hungarian forint, British pound and Canadian dollar during the nine months ended September 30, 2022, as compared with the same period in 2021. Included in the other income, net increase for the period is a $23.6 million foreign currency remeasurement gain associated with a Canadian dollar denominated intercompany loan held by a Euro functional currency entity.
Income Taxes and Tax Rate
| Three Months Ended September 30, | |||||||||||
| (Amounts in millions, except percentages) | 2022 | 2021 | |||||||||
| Provision for (benefit from) income taxes | $ | 1.8 | $ | (10.4) | |||||||
| Effective tax rate | 4.2 | % | (25.2) | % | |||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions, except percentages) | 2022 | 2021 | |||||||||
| Provision for (benefit from) income taxes | $ | 16.6 | $ | (3.9) | |||||||
| Effective tax rate | 18.5 | % | (3.5) | % | |||||||
The effective tax rate of 4.2% for the three months ended September 30, 2022 increased from (25.2)% for the same period in 2021. The effective tax rate varied from the U.S. federal statutory rate for the three months ended September 30, 2022 primarily due to the mitigation of previously recorded BEAT liability and net impact of foreign operations. Refer to Note 13 to our condensed consolidated financial statements included in this Quarterly Report for further discussion.
The effective tax rate of 18.5% for the nine months ended September 30, 2022 increased from (3.5)% for the same period in 2021. The effective tax rate varied from the U.S. federal statutory rate for the nine months ended September 30, 2022 primarily due to the mitigation of previously recorded BEAT liability, the current and anticipated tax impact of the Russia-Ukraine conflict on our business and the net impact of foreign operations. Refer to Note 13 to our condensed consolidated financial statements included in this Quarterly Report for further discussion.
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Other Comprehensive Income (Loss)
| Three Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Other comprehensive income (loss) | $ | (83.1) | $ | (12.0) | |||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Other comprehensive income (loss) | $ | (153.8) | $ | (2.3) | |||||||
Other comprehensive loss for the three months ended September 30, 2022 increased $71.1 million as compared to the same period in 2021. The increased loss was primarily due to foreign currency translation adjustments resulting primarily from exchange rate movements of the Euro, British pound, Indian rupee and Chinese yuan versus the U.S. dollar during the three months ended September 30, 2022, as compared with the same period in 2021.
Other comprehensive loss for the nine months ended September 30, 2022 increased $151.5 million as compared to the same period in 2021. The increased loss was primarily due to foreign currency translation adjustments resulting primarily from exchange rate movements of the Euro, British pound, Indian rupee and Chinese yuan versus the U.S. dollar during the nine months ended September 30, 2022, as compared with the same period in 2021.
Business Segments
We conduct our operations through two business segments based on the type of product and how we manage the business. We evaluate segment performance and allocate resources based on each segment’s operating income. The key operating results for our two business segments, FPD and FCD, are discussed below.
Flowserve Pump Division Segment Results
Our largest business segment is FPD, through which we design, manufacture, distribute and service highly custom engineered pumps, pre-configured industrial pumps, pump systems, mechanical seals, and auxiliary systems (collectively referred to as "original equipment") and related services. FPD primarily operates in the oil and gas, power generation, chemical and general industries. FPD operates in 49 countries with 35 manufacturing facilities worldwide, 10 of which are located in Europe, 11 in North America, eight in Asia and six in Latin America, and it operates 131 QRCs, including those co-located in manufacturing facilities and/or shared with FCD.
| Three Months Ended September 30, | |||||||||||
| (Amounts in millions, except percentages) | 2022 | 2021 | |||||||||
| Bookings | $ | 925.8 | $ | 660.9 | |||||||
| Sales | 592.6 | 601.8 | |||||||||
| Gross profit | 170.0 | 182.9 | |||||||||
| Gross profit margin | 28.7 | % | 30.4 | % | |||||||
| SG&A | 136.9 | 128.5 | |||||||||
| Segment operating income | 38.9 | 59.1 | |||||||||
| Segment operating income as a percentage of sales | 6.6 | % | 9.8 | % | |||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions, except percentages) | 2022 | 2021 | |||||||||
| Bookings | $ | 2,433.6 | $ | 1,982.5 | |||||||
| Sales | 1,783.1 | 1,821.9 | |||||||||
| Gross profit | 510.9 | 562.1 | |||||||||
| Gross profit margin | 28.7 | % | 30.9 | % | |||||||
| SG&A | 408.4 | 394.7 | |||||||||
| Gain on sale of business | — | 1.8 | |||||||||
| Segment operating income | 117.3 | 180.7 | |||||||||
| Segment operating income as a percentage of sales | 6.6 | % | 9.9 | % | |||||||
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Bookings for the three months ended September 30, 2022 increased by $264.9 million, or 40.1%, as compared with the same period in 2021. The increase included negative currency effects of approximately $44 million. The increase in customer bookings was driven by increased customer orders in the oil and gas, chemical, water management and general industries, partially offset by decreased customer orders in the power generation industry. Customer bookings increased $51.0 million into North America, $188.4 million into the Middle East, $16.9 million into Europe and $23.8 million into Latin America and were partially offset by decreased customer orders of $10.8 million into Asia Pacific and $7.7 million into Africa. The increase was more heavily weighted towards original equipment bookings. The increase included the impact of original equipment orders booked in the third quarter of 2022 in excess of $210 million to supply pumps and related equipment to support the development of an onshore unconventional gas project in the Middle East.
Bookings for the nine months ended September 30, 2022 increased by $451.1 million, or 22.8%, as compared with the same period in 2021. The increase included negative currency effects of approximately $97 million. The increase in customer bookings was driven by increased customer orders in the oil and gas, power generation, chemical, general and water management industries. Customer bookings increased $137.1 million into North America, $214.8 million into the Middle East, $24.9 million into Asia Pacific, $85.1 million into Europe, $.1 million into Africa and $9.1 million into Latin America. The increase was more heavily weighted towards original equipment. The increase included the impact of original equipment orders booked in 2022 in excess of $230 million to supply pumps and related equipment to support the development of an onshore unconventional gas project in the Middle East.
Sales for the three months ended September 30, 2022 decreased by $9.2 million, or 1.5% as compared with the same period in 2021 and included negative currency effects of approximately $38 million. The decrease was driven by customer original equipment sales. Decreased customer sales of $28.3 million into Asia Pacific, $7.6 million into Europe and $14.7 million into Latin America were partially offset by increased sales of $18.4 million into North America, $10.1 million into the Middle East and $8.8 million into Africa. In the third quarter of 2022 we experienced operational interruptions related to the implementation of a new enterprise resource planning system at certain of our North America quick response centers. We estimate that this disruption negatively impacted sales volumes during the period by approximately $30 million and we anticipate to largely recover the sales in future periods.
Sales for the nine months ended September 30, 2022 decreased by $38.8 million, or 2.1% as compared with the same period in 2021 and included negative currency effects of approximately $83 million and $5.4 million of negative impact as a result of the reserve for our Russia exposure. The decrease was driven by customer original equipment sales. Decreased customer sales of $73.6 million into Asia Pacific, $37.5 million into Europe and $13.3 million into Latin America were partially offset by increased sales of $54.2 million into North America, $13.7 million into Africa and $9.2 million into the Middle East.
Gross profit for the three months ended September 30, 2022 decreased by $12.9 million, or 7.1%, as compared with the same period in 2021. Gross profit margin for the three months ended September 30, 2022 of 28.7% decreased from 30.4% for the same period in 2021. The decrease in gross profit margin was primarily attributable to the under absorption of $5.1 million of fixed manufacturing costs primarily due to operational interruptions related to the implementation of a new enterprise resource planning system at certain of our North America quick response centers and increased freight costs largely due to global supply chain and logistics constraints, partially offset by a mix shift to higher aftermarket sales, decreased costs related to our realignment actions and lower broad-based annual incentive compensation as compared to the same period in 2021.
Gross profit for the nine months ended September 30, 2022 decreased by $51.2 million, or 9.1%, as compared with the same period in 2021. Gross profit margin for the nine months ended September 30, 2022 of 28.7% decreased from 30.9% for the same period in 2021. The decrease in gross profit margin was primarily attributable to lower conversion of customer backlog to revenue and the under absorption of $5.1 million of fixed manufacturing costs primarily due to operational interruptions related to the implementation of a new enterprise resource planning system at certain of our North America quick response centers, increased freight costs largely due to global supply chain and logistics constraints and a $3.5 million charge taken in the first quarter of 2022 related to our financial exposure in Russia, partially offset by a mix shift to higher margin aftermarket, lower broad-based annual incentive compensation and decreased costs related to our realignment actions as compared to the same period in 2021.
SG&A for the three months ended September 30, 2022 increased by $8.4 million, or 6.5%, as compared with the same period in 2021. Currency effects provided a decrease of approximately $6 million. The increase in SG&A was primarily due to the acquisition and expense of $4.8 million of in-process research and development and higher bad debt expense, partially offset by lower broad-based annual incentive compensation as compared to the same period in 2021.
SG&A for the nine months ended September 30, 2022 increased by $13.7 million, or 3.5%, as compared with the same period in 2021. Currency effects provided a decrease of approximately $15 million. The increase in SG&A was primarily due a $9.1 million charge taken in the first quarter of 2022 related to our financial exposure in Russia and the acquisition and
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expense of $4.8 million of in-process research and development in the third quarter of 2022 and higher bad debt expense, partially offset by lower broad-based annual incentive compensation as compared to the same period in 2021.
Operating income for the three months ended September 30, 2022 decreased by $20.2 million, or 34.2%, as compared with the same period in 2021. The decrease included negative currency effects of approximately $5 million. The decrease was primarily due to the $12.9 million decrease in gross profit and the $8.4 million increase in SG&A.
Operating income for the nine months ended September 30, 2022 decreased by $63.4 million, or 35.1%, as compared with the same period in 2021. The decrease included negative currency effects of approximately $8 million. The decrease was primarily due to the $51.2 million decrease in gross profit and the $13.7 million increase in SG&A.
Backlog of $1,911.1 million at September 30, 2022 increased by $542.2 million, or 39.6%, as compared with December 31, 2021 and include the negative impact of $19.0 million of order cancellations in the first quarter of 2022 due to our exposure in Russia. Currency effects provided a decrease of approximately $100 million.
Flow Control Division Segment Results
FCD designs, manufactures and distributes a broad portfolio of engineered-to-order and configured-to-order isolation valves, control valves, valve automation products and related equipment. FCD leverages its experience and application know-how by offering a complete menu of engineered services to complement its expansive product portfolio. FCD has a total of 44 manufacturing facilities and QRCs in 22 countries around the world, with five of its 19 manufacturing operations located in the U.S., eight located in Europe, five located in Asia Pacific and one located in Latin America. Based on independent industry sources, we believe that FCD is the second largest industrial valve supplier on a global basis.
| Three Months Ended September 30, | |||||||||||
| (Amounts in millions, except percentages) | 2022 | 2021 | |||||||||
| Bookings | $ | 300.0 | $ | 253.6 | |||||||
| Sales | 282.6 | 266.1 | |||||||||
| Gross profit | 78.2 | 77.0 | |||||||||
| Gross profit margin | 27.7 | % | 28.9 | % | |||||||
| SG&A | 48.5 | 49.3 | |||||||||
| Segment operating income | 29.7 | 27.7 | |||||||||
| Segment operating income as a percentage of sales | 10.5 | % | 10.4 | % | |||||||
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions, except percentages) | 2022 | 2021 | |||||||||
| Bookings | $ | 923.2 | $ | 834.0 | |||||||
| Sales | 798.8 | 803.1 | |||||||||
| Gross profit | 218.0 | 236.4 | |||||||||
| Gross profit margin | 27.3 | % | 29.4 | % | |||||||
| SG&A | 142.7 | 147.1 | |||||||||
| Segment operating income | 75.3 | 89.7 | |||||||||
| Segment operating income as a percentage of sales | 9.4 | % | 11.2 | % | |||||||
Bookings for the three months ended September 30, 2022 increased by $46.4 million, or 18.3%, as compared with the same period in 2021. Bookings included negative currency effects of approximately $16 million. The increase in customer bookings was primarily driven by increased customer orders in the chemical, oil and gas and power generation industries, partially offset by decreased customer orders in the general and water management industries. Increased customer bookings were driven by increased orders of $24.3 million into North America, $8.7 million into Asia Pacific, $0.2 million into Africa, $4.2 million into Europe, $7.3 million into the Middle East and $2.0 million into Latin America. The increase was driven by both customer original equipment and aftermarket bookings.
Bookings for the nine months ended September 30, 2022 increased by $89.2 million, or 10.7%, as compared with the same period in 2021. Bookings included negative currency effects of approximately $36 million. The increase in customer bookings was primarily driven by increased customer orders in the chemical, oil and gas, water management and general industries, partially offset by decreased customer orders in the power generation industry. Increased customer orders of $42.8 million into North America, $16.3 million into Europe, $4.9 million into Africa, $14.8 million into the Middle East and $3.2 million into
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Latin America and $8.4 million into Asia Pacific. The increase was driven by both customer original equipment and aftermarket bookings.
Sales for the three months ended September 30, 2022 increased $16.5 million, or 6.2%, as compared with the same period in 2021. The increase included negative currency effects of approximately $17 million. Increased sales were driven by both original equipment and aftermarket sales. The increase was primarily driven by increased customer sales of $21.9 million into North America and $1.3 million into Africa, partially offset by decreased $1.4 million into the Middle East, $0.5 million into Europe, $0.3 million into Latin America and $3.1 million into Asia Pacific.
Sales for the nine months ended September 30, 2022 decreased $4.3 million, or 0.5%, as compared with the same period in 2021. The decrease included negative currency effects of approximately $33 million. Decreased sales were driven by original equipment sales. The decrease was primarily driven by decreased customer sales of $30.5 million into Asia Pacific, $3.6 million into Africa, $7.4 million into the Middle East, $17.1 million into Europe and $5.5 million into Latin America, partially offset by increased customer sales of $61.3 million into North America.
Gross profit for the three months ended September 30, 2022 increased by $1.2 million, or 1.6%, as compared with the same period in 2021. Gross profit margin for the three months ended September 30, 2022 of 27.7% decreased from the 28.9% for the same period in 2021. The decrease in gross profit margin was primarily attributable to increased freight costs largely due to global supply chain and logistics constraints and the establishment of $1.7 million of inventory reserves related to certain contracts that are estimated to be below market, partially offset by lower broad-based annual incentive compensation as compared to the same period in 2021.
Gross profit for the nine months ended September 30, 2022 decreased by $18.4 million, or 7.8%, as compared with the same period in 2021. Gross profit margin for the nine months ended September 30, 2022 of 27.3% decreased from the 29.4% for the same period in 2021. The decrease in gross profit margin was primarily attributable to increased freight costs largely due to global supply chain and logistics constraints, the establishment of $1.7 million of inventory reserves related to certain contracts that are estimated to be below market and a $1.1 million charge taken in the first quarter of 2022 related to our financial exposure in Russia, partially offset by lower broad-based annual incentive compensation as compared to the same period in 2021.
SG&A for the three months ended September 30, 2022 decreased by $0.8 million, or 1.6%, as compared with the same period in 2021. Currency effects provided a decrease of approximately $3 million. The decrease in SG&A was primarily due to lower broad-based annual incentive compensation as compared to the same period in 2021.
SG&A for the nine months ended September 30, 2022 decreased by $4.4 million, or 3.0%, as compared with the same period in 2021. Currency effects provided a decrease of approximately $5 million. The decrease in SG&A was primarily due to lower broad-based annual incentive compensation, partially offset by a $1.1 million charge taken in the first quarter of 2022 related to our financial exposure in Russia, higher bad debt expense and a discrete asset write-down in the second quarter of 2022 as compared to the same period in 2021.
Operating income for the three months ended September 30, 2022 increased by $2.0 million, or 7.2%, as compared with the same period in 2021. The increase included negative currency effects of approximately $1 million. The increase was primarily due to the $1.2 million increase in gross profit and the $0.8 million decrease in SG&A.
Operating income for the nine months ended September 30, 2022 decreased by $14.4 million, or 16.1%, as compared with the same period in 2021. The decrease included negative currency effects of approximately $2 million. The decrease was primarily due to the $18.4 million decrease in gross profit, partially offset by the $4.4 million decrease in SG&A.
Backlog of $701.8 million at September 30, 2022 increased by $62.0 million, or 9.7%, as compared with December 31, 2021 and include the negative impact of $9.8 million of order cancellations in the first quarter of 2022 due to our exposure in Russia. Currency effects provided a decrease of approximately $38 million.
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LIQUIDITY AND CAPITAL RESOURCES
Cash Flow and Liquidity Analysis
| Nine Months Ended September 30, | |||||||||||
| (Amounts in millions) | 2022 | 2021 | |||||||||
| Net cash flows provided (used) by operating activities | $ | (109.5) | $ | 151.1 | |||||||
| Net cash flows provided (used) by investing activities | (45.6) | (38.7) | |||||||||
| Net cash flows provided (used) by financing activities | (111.8) | 272.3 | |||||||||
Existing cash, cash generated by operations and borrowings available under the Senior Credit Facility are our primary sources of short-term liquidity. We monitor the depository institutions that hold our cash and cash equivalents on a regular basis, and we believe that we have placed our deposits with creditworthy financial institutions. Our sources of operating cash generally include the sale of our products and services and the conversion of our working capital, particularly accounts receivable and inventories. Our cash balance at September 30, 2022 was $351.9 million as compared with $658.5 million at December 31, 2021.
Our cash balance decreased by $306.6 million to $351.9 million at September 30, 2022, as compared with December 31, 2021. The cash activity during the first nine months of 2022 included cash used by operating activities, $78.4 million in dividend payments, $45.8 million in capital expenditures and $24.2 million of payments on our Term Loan.
For the nine months ended September 30, 2022, our cash used by operating activities was $109.5 million, as compared to cash provided of $151.1 million for the same period in 2021. Cash flow provided from working capital decreased for the nine months ended September 30, 2022, due primarily to increased cash flows used by or decreased cash flows provided by accounts receivable, inventory, contract assets, prepaid expenses and other, accrued liabilities and income tax payable, partially offset by increased cash flows provided by or decreased cash flows used by contract liabilities, accounts payable and retirement obligations and other liabilities as compared to the same period in 2021.
Increases in accounts receivable used $78.4 million of cash flow for the nine months ended September 30, 2022, as compared to provided $24.4 million for the same period in 2021. As of September 30, 2022, our days’ sales outstanding ("DSO") was 79 days as compared with 74 days as of September 30, 2021.
Increases in contract assets used $21.9 million of cash flow for the nine months ended September 30, 2022, as compared with cash flows provided of $35.4 million for the same period in 2021.
Increases in inventory used $151.9 million and $47.5 million of cash flow for the nine months ended September 30, 2022 and September 30, 2021, respectively. Inventory turns were 3.1 times at September 30, 2022, as compared to 3.5 as of September 30, 2021.
Increases in accounts payable provided $29.3 million of cash flow for the nine months ended September 30, 2022, as compared with $58.6 million cash used for the same period in 2021. Decreases in accrued liabilities and income taxes payable used $32.7 million of cash flow for the nine months ended September 30, 2022, as compared with $9.1 million of cash flow provided for the same period in 2021. Cash used from accrued liabilities and income tax payable included a one-time tax payment of approximately $30 million associated with accrued withholding taxes related to foreign undistributed earnings for the nine months ended September 30, 2022.
Increases in contract liabilities provided $27.2 million of cash flow for the nine months ended September 30, 2022, as compared to cash flows provided of $9.4 million for the same period in 2021.
Cash flows used by investing activities during the nine months ended September 30, 2022 were $45.6 million, as compared to $38.7 million for the same period in 2021. Capital expenditures during the nine months ended September 30, 2022 were $45.8 million, an increase of $11.8 million as compared with the same period in 2021. Our capital expenditures are generally focused on strategic initiatives to pursue information technology infrastructure, ongoing scheduled replacements and upgrades and cost reduction opportunities. In 2022, we currently estimate capital expenditures to be between $60 million and $70 million before consideration of any acquisition activity. In addition, proceeds received during the nine months ended September 30, 2022 from disposal of assets provided $0.4 million. Proceeds received during the nine months ended September 30, 2021 from disposal of assets provided $2.5 million.
Cash flows used by financing activities during the nine months ended September 30, 2022 were $111.8 million, as compared to $272.3 million of cash flows provided for the same period in 2021. Cash outflows in the nine months ended September 30, 2022 resulted primarily from the $24.2 million of payments on our Term Loan and $78.4 million of dividend payments. Cash inflows during the nine months ended September 30, 2021 resulted primarily from $498.3 million of proceeds related to the 2032 Senior Notes issuance, $300.0 million proceeds related to the unsecured term loan facility draw, partially
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offset by a $407.5 million payment on long-term debt resulting from the redemption of our 2022 Euro Senior Notes, $78.6 million of dividend payments and the repurchase of $17.5 million of common shares.
Our Amended and Restated Credit Agreement matures in September 13, 2026. Approximately $10 million of our outstanding Term Loan Facility is due to mature in the remainder of 2022 and approximately $40 million in 2023. As of September 30, 2022, we had an available capacity of $157.3 million on our Senior Credit Facility, which provides for a $800.0 million unsecured revolving credit facility with a maturity date of September 13, 2026. Our borrowing capacity is subject to financial covenant limitations based on the terms of our Senior Credit Facility and is also reduced by outstanding letters of credit. Our Senior Credit Facility is committed and held by a diversified group of financial institutions. Refer to Note 6 to our condensed consolidated financial statements included in this Quarterly Report for additional information concerning our Senior Credit Facility.
During the nine months ended September 30, 2022 we have made no cash contributions to our U.S. pension plan. At December 31, 2021, our U.S. pension plan was fully funded as defined by applicable law. After consideration of our funded status, we currently do not anticipate making any contributions to our U.S. pension plan in 2022. We continue to maintain an asset allocation consistent with our strategy to maximize total return, while reducing portfolio risks through asset class diversification.
Considering our current debt structure and cash needs, we currently believe cash flows generated from operating activities combined with availability under our Senior Credit Facility and our existing cash balance will be sufficient to meet our cash needs for our short-term (next 12 months) and long-term (beyond the next 12 months) business needs. Cash flows from operations could be adversely affected by economic, political and other risks associated with sales of our products, operational factors, competition, fluctuations in foreign exchange rates and fluctuations in interest rates, among other factors. See "Financing" and "Cautionary Note Regarding Forward-Looking Statements" below.
As of September 30, 2022, we have $96.1 million of remaining capacity for Board of Directors approved share repurchases. While we currently intend to continue to return cash through dividends and/or share repurchases for the foreseeable future, any future returns of cash through dividends and/or share repurchases will be reviewed individually, declared by our Board of Directors at its discretion and implemented by management.
Financing
Credit Facilities
See Note 6 to our condensed consolidated financial statements included in this Quarterly Report for a discussion of our Senior Credit Facility and related covenants. We were in compliance with all applicable covenants under our Senior Credit Facility as of September 30, 2022.
As of September 30, 2022, we have cash and cash equivalents of $351.9 million and $157.3 million of borrowings available under our Senior Credit Facility. On October 14, 2022, the Company borrowed $45.0 million on the Revolving Credit Facility for general corporate purposes. We do not currently anticipate, nor are we aware of, any significant market conditions or commitments that would change any of our conclusions of the liquidity currently available to us. Additionally, we expect that the costs savings measures planned and already in place will enable us to maintain adequate liquidity over the short-term (next 12 months) and long-term (beyond the next 12 months) as we manage through the current market environment. We will continue to actively monitor the potential impacts of COVID-19 and related events on the credit markets in order to maintain sufficient liquidity and access to capital.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management’s discussion and analysis of financial condition and results of operations are based on our condensed consolidated financial statements and related footnotes contained within this Quarterly Report. Our critical accounting policies used in the preparation of our condensed consolidated financial statements were discussed in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our 2021 Annual Report. The critical policies, for which no significant changes have occurred in the nine months ended September 30, 2022, include:
•Revenue Recognition;
•Deferred Taxes, Tax Valuation Allowances and Tax Reserves;
•Reserves for Contingent Loss;
•Pension and Postretirement Benefits; and
•Valuation of Goodwill, Indefinite-Lived Intangible Assets and Other Long-Lived Assets.
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The process of preparing condensed consolidated financial statements in conformity with U.S. GAAP requires the use of estimates and assumptions to determine certain of the assets, liabilities, revenues and expenses. These estimates and assumptions are based upon what we believe is the best information available at the time of the estimates or assumptions. The estimates and assumptions could change materially as conditions within and beyond our control change. Accordingly, actual results could differ materially from those estimates. The significant estimates are reviewed quarterly with the Audit Committee of our Board of Directors.
Based on an assessment of our accounting policies and the underlying judgments and uncertainties affecting the application of those policies, we believe that our condensed consolidated financial statements provide a meaningful and fair perspective of our consolidated financial condition and results of operations. This is not to suggest that other general risk factors, such as changes in worldwide demand, changes in material costs, performance of acquired businesses and others, could not adversely impact our consolidated financial condition, results of operations and cash flows in future periods. See "Cautionary Note Regarding Forward-Looking Statements" below.
ACCOUNTING DEVELOPMENTS
We have presented the information about pronouncements not yet implemented in Note 1 to our condensed consolidated financial statements included in this Quarterly Report.
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended. Words or phrases such as, "may," "should," "expects," "could," "intends," "plans," "anticipates," "estimates," "believes," "predicts" or other similar expressions are intended to identify forward-looking statements, which include, without limitation, statements concerning our future financial performance, future debt and financing levels, investment objectives, implications of litigation and regulatory investigations and other management plans for future operations and performance.
The forward-looking statements included in this Quarterly Report are based on our current expectations, projections, estimates and assumptions. These statements are only predictions, not guarantees. Such forward-looking statements are subject to numerous risks and uncertainties that are difficult to predict. These risks and uncertainties may cause actual results to differ materially from what is forecast in such forward-looking statements and are currently, or in the future could be, amplified by the COVID-19 pandemic. Specific factors that might cause such a difference include, without limitation, the following:
•uncertainties related to the impact of the COVID-19 pandemic on our business and operations, financial results and financial position, our customers and suppliers, and on the global economy, including its impact on our sales;
•a portion of our bookings may not lead to completed sales, and our ability to convert bookings into revenues at acceptable profit margins;
•changes in the global financial markets and the availability of capital and the potential for unexpected cancellations or delays of customer orders in our reported backlog;
•our dependence on our customers' ability to make required capital investment and maintenance expenditures. The liquidity and financial position of our customers could impact capital investment decisions and their ability to pay in full and/or on a timely basis;
•if we are not able to successfully execute and realize the expected financial benefits from our strategic transformation, realignment and other cost-saving initiatives, our business could be adversely affected;
•risks associated with cost overruns on fixed fee projects and in accepting customer orders for large complex custom engineered products;
•the substantial dependence of our sales on the success of the oil and gas, chemical, power generation and water management industries;
•the adverse impact of volatile raw materials prices on our products and operating margins;
•economic, political and other risks associated with our international operations, including military actions, trade embargoes or changes to tariffs or trade agreements that could affect customer markets, particularly North African, Russian and Middle Eastern markets and global oil and gas producers, and non-compliance with U.S. export/reexport control, foreign corrupt practice laws, economic sanctions and import laws and regulations;
•increased aging and slower collection of receivables, particularly in Latin America and other emerging markets;
•our exposure to fluctuations in foreign currency exchange rates, particularly the Euro and British pound and in
hyperinflationary countries such as Venezuela and Argentina;
•our furnishing of products and services to nuclear power plant facilities and other critical applications;
•potential adverse consequences resulting from litigation to which we are a party, such as litigation involving asbestos-containing material claims;
•expectations regarding acquisitions and the integration of acquired businesses;
•our relative geographical profitability and its impact on our utilization of deferred tax assets, including foreign tax credits;
•the potential adverse impact of an impairment in the carrying value of goodwill or other intangible assets;
•our dependence upon third-party suppliers whose failure to perform timely could adversely affect our business operations;
•the highly competitive nature of the markets in which we operate;
•environmental compliance costs and liabilities;
•potential work stoppages and other labor matters;
•access to public and private sources of debt financing;
•our inability to protect our intellectual property in the U.S., as well as in foreign countries;
•obligations under our defined benefit pension plans;
•our internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud;
•the recording of increased deferred tax asset valuation allowances in the future or the impact of tax law changes on such deferred tax assets could affect our operating results;
•risks and potential liabilities associated with cyber security threats; and
•ineffective internal controls could impact the accuracy and timely reporting of our business and financial results.
These and other risks and uncertainties are more fully discussed in the risk factors identified in "Item 1A. Risk Factors" in Part I of our 2021 Annual Report and Part II of this Quarterly Report, and may be identified in our Quarterly Reports on Form 10-Q and our other filings with the SEC and/or press releases from time to time. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any forward-looking statement.
Item 3.Quantitative and Qualitative Disclosures About Market Risk.
We have market risk exposure arising from changes in foreign currency exchange rate movements in foreign exchange forward contracts. We are exposed to credit-related losses in the event of non-performance by counterparties to financial instruments, but we currently expect our counterparties will continue to meet their obligations given their current creditworthiness.
LIBOR
On March 5, 2021, the UK Financial Conduct Authority (“FCA”), which regulates the London Interbank Offered Rate (“LIBOR”) issued an announcement on the future cessation or loss of representativeness of LIBOR benchmark settings currently published by ICE Benchmark Administration. That announcement confirmed that LIBOR will either cease to be provided by any administrator or will no longer be representative after December 31, 2021 for all non-USD LIBOR reference rates, and for 1-Week and 2-Month USD LIBOR and after June 30, 2023 for other USD LIBOR reference rates. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rate Committee, has proposed the replacement of U.S. dollar LIBOR rates with a new index calculated by short-term repurchase agreements backed by U.S. Treasury securities called the Secured Overnight Financing Rate (“SOFR”). Whether or not SOFR is generally accepted as the LIBOR replacement remains in question and the future of LIBOR at this time is uncertain. The Company’s Amended and Restated Credit Agreement includes a provision for the determination of a successor LIBOR rate when appropriate by reference to the then-prevailing market convention for determining an interest rate for syndicated loans in the United States, subject to a right of the lenders thereunder to reject the application of the determined rate by written notice. While we will work with our administrative agent to incorporate a successor reference rate, there can be no assurances as to what alternative reference rates may be and whether such rates will be more or less favorable than LIBOR and any other unforeseen impacts of the potential discontinuation of LIBOR.
Foreign Currency Exchange Rate Risk
A substantial portion of our operations are conducted by our subsidiaries outside of the U.S. in currencies other than the U.S. dollar. Almost all of our non-U.S. subsidiaries conduct their business primarily in their local currencies, which are also their functional currencies. Foreign currency exposures arise from translation of foreign-denominated assets and liabilities into U.S. dollars and from transactions, including firm commitments and anticipated transactions, denominated in a currency other than our or a non-U.S. subsidiary’s functional currency. As a means of managing the volatility of foreign currency exposure with the Euro/U.S. dollar exchange rate, we entered into three swap agreements associated with our Euro investment in certain of our international subsidiaries. The swap agreements are designated as a net investment hedges and as of September 30, 2022, the notional value of the swaps agreements was €423.2 million. Routinely, we review our investments in foreign subsidiaries from a long-term perspective and use capital structuring techniques to manage our investment in foreign subsidiaries as deemed necessary. For further discussion related to these swap agreements refer to Note 5 to our condensed consolidated financial statements included in this Quarterly Report. We recognized net gains (losses) associated with foreign currency translation of $(89.3) million and $(15.6) million for the three months ended September 30, 2022 and 2021, respectively, and $(170.2) million and $(12.5) million for the nine months ended September 30, 2022 and 2021, respectively, which are included in other comprehensive income (loss).
We employ a foreign currency risk management strategy to minimize potential changes in cash flows from unfavorable foreign currency exchange rate movements. Where available, the use of foreign exchange forward contracts allows us to mitigate transactional exposure to exchange rate fluctuations as the gains or losses incurred on the foreign exchange forward contracts will offset, in whole or in part, losses or gains on the underlying foreign currency exposure. As of September 30, 2022, we had a U.S. dollar equivalent of $399.6 million in aggregate notional amount outstanding in foreign exchange forward contracts with third parties, as compared with $425.2 million at December 31, 2021. Transactional currency gains and losses arising from transactions outside of our sites’ functional currencies and changes in fair value of non-designated foreign exchange forward contracts are included in our consolidated results of operations. We recognized foreign currency net gains (losses) of $30.5 million and $(1.1) million for the three months ended September 30, 2022 and 2021, respectively, and $34.9 million and $(14.8) million for the nine months ended September 30, 2022 and 2021, respectively, are included in other income (expense), net in the accompanying condensed consolidated statements of income.
Based on a sensitivity analysis at September 30, 2022, a 10% change in the foreign currency exchange rates for the nine months ended September 30, 2022 would have impacted our net earnings by approximately $5 million. This calculation assumes that all currencies change in the same direction and proportion relative to the U.S. dollar and that there are no indirect effects, such as changes in non-U.S. dollar sales volumes or prices. This calculation does not take into account the impact of the foreign currency exchange forward contracts discussed above.
Item 4.Controls and Procedures.
Disclosure Controls and Procedures
Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) are controls and other procedures that are designed to ensure that the information that we are required to disclose in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
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In connection with the preparation of this Quarterly Report, our management, under the supervision and with the participation of our Principal Executive Officer and Principal Financial Officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2022. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2022.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter ended September 30, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II — OTHER INFORMATION
Item 1.Legal Proceedings.
We are party to the legal proceedings that are described in Note 10 to our condensed consolidated financial statements included in "Item 1. Financial Statements" of this Quarterly Report, and such disclosure is incorporated by reference into this "Item 1. Legal Proceedings." In addition to the foregoing, we and our subsidiaries are named defendants in certain other ordinary routine lawsuits incidental to our business and are involved from time to time as parties to governmental proceedings, all arising in the ordinary course of business. Although the outcome of lawsuits or other proceedings involving us and our subsidiaries cannot be predicted with certainty, and the amount of any liability that could arise with respect to such lawsuits or other proceedings cannot be predicted accurately, management does not currently expect the amount of any liability that could arise with respect to these matters, either individually or in the aggregate, to have a material adverse effect on our financial position, results of operations or cash flows.
Item 1A.Risk Factors.
There are numerous factors that affect our business, financial condition, results of operations, cash flows, reputation and/or prospects, many of which are beyond our control. In addition to other information set forth in this Quarterly Report, careful consideration should be given to "Item 1A. Risk Factors" in Part I and "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations" in Part II of our 2021 Annual Report, which contain descriptions of significant factors that might cause the actual results of operations in future periods to differ materially from those currently projected in the forward-looking statements contained therein.
There have been no material changes in risk factors discussed in our 2021 Annual Report and subsequent SEC filings. The risks described in this Quarterly Report filed for the period ended September 30, 2022, our 2021 Annual Report and in our other SEC filings or press releases from time to time are not the only risks we face. Additional risks and uncertainties are currently deemed immaterial based on management's assessment of currently available information, which remains subject to change; however, new risks that are currently unknown to us may surface in the future that materially adversely affect our business, financial condition, results of operations or cash flows.
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds.
Note 12 to our condensed consolidated financial statements included in this Quarterly Report includes a discussion of our share repurchase program and payment of quarterly dividends on our common stock.
During the quarter ended September 30, 2022, we had no repurchases of our common stock shares. As of September 30, 2022, we have $96.1 million of remaining capacity under our current share repurchase program. The following table sets forth the activity for each of the three months during the quarter ended September 30, 2022:
| Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Program (1) | Maximum Number of Shares (or Approximate Dollar Value) That May Yet Be Purchased Under the Program (in millions) | ||||||||||||||||||||
| Period | |||||||||||||||||||||||
| July 1 - 31 | 382 | (2) | $ | 29.33 | — | $ | 96.1 | ||||||||||||||||
| August 1 - 31 | 1,069 | (3) | 33.46 | — | 96.1 | ||||||||||||||||||
| September 1 - 30 | 193 | (2) | 25.05 | — | 96.1 | ||||||||||||||||||
| Total | 1,644 | $ | 31.51 | — | |||||||||||||||||||
__________________________________
(1)On November 13, 2014, our Board of Directors approved a $500.0 million share repurchase authorization. Our share repurchase program does not have an expiration date, and we reserve the right to limit or terminate the repurchase program at any time without notice.
(2)Represents shares that were tendered by employees to satisfy minimum tax withholding amounts for Restricted Shares.
(3)Includes 213 shares that were tendered by employees to satisfy minimum tax withholding amounts for Restricted Shares at an average price per share of $32.88 and 856 shares purchased at a price of $33.60 per share by a rabbi trust that we established in connection with our director deferral plans, pursuant to which non-employee directors may elect to defer directors’ quarterly cash compensation to be paid at a later date in the form of common stock.
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Item 3.Defaults Upon Senior Securities.
None
Item 4.Mine Safety Disclosures.
Not applicable.
Item 5.Other Information.
None
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Item 6.Exhibits
| Exhibit No. | Description | |||||||
| Restated Certificate of Incorporation of Flowserve Corporation, as amended and restated effective May 20, 2021 (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on May 25, 2021). | ||||||||
| Flowserve Corporation By-Laws, as amended and restated effective August 16, 2022 (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on August 17, 2022). | ||||||||
Flowserve Corporation Executive Officer Severance Plan, as amended and restated August 17, 2022*. | ||||||||
Flowserve Corporation Annual Incentive Plan, as amended and restated August 17, 2022*. | ||||||||
| Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||||||||
| Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||||||||
| Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||||||||
| Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||||||||
| 101.INS | XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | |||||||
| 101.SCH | XBRL Taxonomy Extension Schema Document | |||||||
| 101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |||||||
| 101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |||||||
| 101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | |||||||
| 101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | |||||||
| 104 | The cover page from the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2022, formatted in Inline XBRL (included as Exhibit 101) | |||||||
_______________________
*Management contracts and compensatory plans and arrangements required to be filed as exhibits to this Quarterly Report on Form 10-Q.
+ Filed herewith.
++ Furnished herewith.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| FLOWSERVE CORPORATION | |||||||||||
| Date: | October 31, 2022 | /s/ Amy B. Schwetz | |||||||||
| Amy B. Schwetz | |||||||||||
| Senior Vice President and Chief Financial Officer (Principal Financial Officer) | |||||||||||
| Date: | October 31, 2022 | /s/ Scott K. Vopni | |||||||||
| Scott K. Vopni | |||||||||||
| Vice President and Chief Accounting Officer (Principal Accounting Officer) | |||||||||||
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