(EDGAR Online via COMTEX) -- 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.
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 153 QRCs located around the globe, provides a variety of service offerings for our 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. Table of Contents
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.
Our cross-functional crisis management team established during the first quarter of 2020 has continued monitoring and making recommendations to management to help us continue operating as an essential business, while also protecting the health and safety of our associates. We continue to actively monitor the impacts of the COVID-19 pandemic on all aspects of our business and geographies.
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.
Health and Safety of Our Associates
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 recent spikes in cases of the virus and its variants in various geographies in which we operate. These recent spikes related to the Omicron variant have caused significant disruption in certain geographies where we operate, including in Europe and China, which contributed to the labor availability and other COVID-19 operational challenges faced during the first quarter of 2022. Our associates have continued to demonstrate strong resilience in adapting to continually evolving health and safety guidelines while addressing these challenging times and providing products and services to our customers.
At the beginning of the pandemic we implemented policies and practices to help protect our workforce so they can safely and effectively carry out their vital work, and we have continued to revise those policies and practices in light of guidance received from local and regional health authorities where appropriate.
Our employees and facilities have a key role in keeping essential infrastructure and industries operating, including oil and gas, water, chemical, power generation and other essential industries, such as food and beverage and healthcare. While all of our facilities generally remain open and operational, we continue to occasionally experience temporary shutdowns in specific geographies as a result of COVID-19 disruption, such as the recent government-mandated shutdowns in Shanghai, China. 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 in the first quarter of 2022, we continue to expect a decline of these adverse impacts as we navigate further through the pandemic in 2022.
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During the first three months of 2022, the ongoing effects of the COVID-19 pandemic in global markets has 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 customers reduced capital expenditures and budgets in 2020. To date, while spending for maintenance and repair projects and aftermarket services have returned close to pre-pandemic levels over the past several quarters, project-based customer spending has yet to return to pre-pandemic levels despite some meaningful improvement in the first three months of 2022. In this regard, we saw an overall increase in bookings of 14.9% in the first three months of 2022 as compared to the same period in 2021. Despite the meaningful improvement in customer spending, during the first quarter of 2022 we continued to experience customer-driven delays in the witnessing and inspection necessary to take delivery of equipment, which we expect will continue as long as we and our customers continue to experience the supply chain and logistics headwinds described below under the heading "Supply Chain Impact."
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 quarter of 2022, that will ultimately need to be completed, the timing will largely depend on the duration of the COVID-19 pandemic and how the virus continues to spread in our customers' various geographies, given the impact of the pandemic on demand, utilization and required maintenance. While we saw some recovery in capital expenditure budgets in the first quarter of 2022, capital spending did not approach pre-pandemic levels. We expect planned capital spending to increase through the rest of 2022 but remain below pre-pandemic levels.
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. Additionally, the additional global supply chain and logistics constraints that have been affecting global markets since the third quarter of 2021 have continued to cause additional headwinds in the first quarter 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 the COVID-19 pandemic and ongoing global supply chain and logistics headwinds continue.
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 - Three months ended March 31, 2022 and 2021"), reductions in capital expenditures and continued cuts in other discretionary spending due to our response to the 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 of Our Associates." We continue to evaluate additional cost savings measures in order to reduce the impact of the COVID-19 pandemic on our financial results.
We continually monitor and assess the spread of COVID-19 and known variants, including in areas that have seen recent increases in cases, and we will continue to adapt our operations to respond the changing conditions as needed. During the first quarter, 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 second half of 2021. As we continue to Table of Contents
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.
Impact of Russia-Ukraine Conflict on our Business
In response to the recent and 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 continue throughout 2022.
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 a 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.
The following table presents the above impacts of the Russia pre-tax charge:
Three Months Ended March 31, 2022 (Amounts in thousands) FPD FCD Consolidated Total Sales $ (5,429) $ (2) $ (5,431) Cost of sales 3,510 1,112 4,622 Gross loss (8,939) (1,114) (10,053) Selling, general and administrative expense 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. 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.
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 are expected to continue into the first half 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 March 31, 2022, we have cash and cash equivalents of $575.8 million and $383.5 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 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 12 months from the issuance date of these financial statements.
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RESULTS OF OPERATIONS - Three months ended March 31, 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 2020 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.
Realignment Activity The following tables present out realignment activity by segment related to our 2020 Realignment Program: Three Months Ended March 31, 2022 Subtotal-Reportable Eliminations and (Amounts in thousands) FPD FCD Segments All Other Consolidated Total Total Realignment Charges COS $ (83) $ (54) $ (137) $ (61) $ (198) SG&A 75 17 92 (293) (201) Total $ (8) $ (37) $ (45) $ (354) $ (399) Three Months Ended March 31, 2021 Subtotal-Reportable Eliminations and (Amounts in thousands) FPD FCD Segments All Other Consolidated Total Total Realignment Charges COS $ 7,919 $ 897 $ 8,816 $ 590 $ 9,406 SG&A 157 $ 859 1,016 3,280 4,296 Total $ 8,076 $ 1,756 $ 9,832 $ 3,870 $ 13,702
Consolidated Results Bookings, Sales and Backlog Three Months Ended March 31, (Amounts in millions) 2022 2021 Bookings $ 1,086.1 $ 945.0 Sales 821.1 857.3
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 March 31, 2022 increased by $141.1 million, or 14.9%, as compared with the same period in 2021. The increase included negative currency effects of approximately $26 million. The increase was driven by increased customer orders in the oil and gas, power generation and the water management industries, partially offset by decreased customer orders in the chemical and general industries. The increase in customer bookings was more heavily weighted towards aftermarket bookings.
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Sales for the three months ended March 31, 2022 decreased by $36.2 million, or 4.2%, as compared with the same period in 2021. The decrease included negative currency effects of approximately $19 million and $5.4 million of negative impact as a result of the reserve of our Russia exposure. The decreased sales were driven by both original equipment and aftermarket, with decreased sales into Europe, Asia Pacific and the Middle East and Africa, partially offset by increased sales into Latin America and North America. Net sales to international customers, including export sales from the U.S., were approximately 62% and 68% of total sales for the three months ended March 31, 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 $2,229.8 million at March 31, 2022 increased by $226.2 million, or 11.3%, 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 $15 million. Approximately 38% of the backlog at both March 31, 2022 and December 31, 2021 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 $544 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 March 31, (Amounts in millions, except percentages) 2022 2021 Gross profit $ 209.6 $ 250.9 Gross profit margin 25.5 % 29.3 %
Gross profit for the three months ended March 31, 2022 decreased by $41.3 million, or 16.5%, as compared with the same period in 2021. Gross profit margin for the three months ended March 31, 2022 of 25.5% decreased from 29.3% for the same period in 2021. The decrease in gross profit margin was primarily due to revenue recognized on lower margin original equipment orders, lower conversion of customer backlog to revenue and increased freight costs largely due to global supply chain and logistics constraints, a $4.6 million charge taken in the first quarter of 2022 related to our financial exposure in Russia and under absorption of fixed manufacturing costs. Aftermarket sales represented approximately 53% of total sales for both periods in 2022 and 2021.
Selling, General and Administrative Expense Three Months Ended March 31, (Amounts in millions, except percentages) 2022 2021 SG&A $ 206.1 $ 198.3 SG&A as a percentage of sales 25.1 % 23.1 %
SG&A for the three months ended March 31, 2022 increased by $7.8 million, or 3.9%, as compared with the same period in 2021. Currency effects yielded a decrease of approximately $5 million. SG&A as a percentage of sales for the three months ended March 31, 2022 increased 200 basis points primarily due to a $10.2 million charge taken in the first quarter of 2022 related to our financial exposure in Russia and lower sales leverage, partially offset by lower broad-based annual incentive compensation as compared with the same period in 2021.
Net Earnings from Affiliates
Three Months Ended March 31, (Amounts in millions) 2022 2021 Net earnings from affiliates $ 3.9 $ 3.5
Net earnings from affiliates for the three months ended March 31, 2022 increased $0.4 million, or 11.4%, 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 March 31, (Amounts in millions, except percentages) 2022 2021 Operating income $ 7.4 $ 56.1 Operating income as a percentage of sales 0.9 % 6.5 %
Operating income for the three months ended March 31, 2022 decreased by $48.7 million, or 86.8%, as compared with the same period in 2021. The decrease included currency benefits of approximately $1 million. The decrease was primarily a result of the $41.3 million decrease in gross profit and the $7.8 million increase in SG&A.
Interest Expense and Interest Income Three Months Ended March 31, (Amounts in millions) 2022 2021 . . .
May 02, 2022
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