Flowserve Corporation

Thank you, Sarah, and good morning, everyone. We appreciate you participating in our conference call today to discuss FlowServe's first quarter 2022 financial results. On the call with me this morning are Scott Rowe, FlowServe's President and Chief Executive Officer, and Amy Schwetz, Senior Vice President and Chief Financial Officer. Following our prepared comments, we will open the call for questions. As a reminder, this event is being webcast and an audio replay will be available. Please also note that our earnings materials do, and this call will, include non-GAAP measures and contain forward-looking statements. These statements are based upon forecasts, expectations, and other information available to management as of May 3, 2022, and they involve risks and uncertainties, many of which are beyond the company's control. We encourage you to fully review our safe harbor disclosures, as well as our reconciliation of our non-GAAP measures to our reported results, both of which are included in our press release and earnings presentation and are accessible on our website at flowserv.com in the investor relations section. I would now like to turn the call over to Scott Rowe, Flowserv's President and Chief Executive Officer, for his prepared comments. Thanks, Jay, and good morning, everyone.

Thank you for joining our first quarter earnings call. I want to start with an overview of our bookings and then quickly turn to our global operations in the first quarter results. Clearly, the highlight of the first quarter was our success in capitalizing on the improving demand environment, including the award of several midsize projects, which contributed to FlowServe achieving its highest bookings level since the second quarter of 2019. First quarter bookings of $1.09 billion increased 15% over prior year and about 18% on a constant currency basis. This level was also up 12% sequentially compared to last year's fourth quarter, which was the highest bookings quarter of 2021. As a later cycle company, we are encouraged by the demand improvement that we have seen in our served-in markets this year and our ability to profitably win those opportunities. Based on the trends we're observing today, we believe that these market dynamics will remain strong in the coming months. Let me now turn to our global operations. The first quarter was significantly more challenging than we had anticipated in mid-February. Throughout the quarter, the global operating environment got worse and inflation accelerated. The combination of supply chain constraints, logistics disruption, labor availability headwinds, and significant inflation inhibited our ability to serve our customers, and recognized revenue. As a result, increased underabsorption and higher costs eroded the margins in the quarter. The Russia-Ukraine situation added further complexities to our operations. Together, these factors, combined with general volatility, drove our backlogged conversion performance significantly below historical norms. In the quarter, our conversion fell to just 41%, with all regions and facilities impacted at similar levels. To put that number in context, our 2021 backlog conversion averaged 46%. We are taking significant actions to restore our revenue conversion rates to historical levels and improve our overall margins. Everyone in our organization, including myself, is fully focused on working through this challenging situation. We have implemented revenue cadence meetings at all levels of the operation, created tiger teams for problematic categories and other procured items, enhanced our planning capabilities accelerated our recruiting to fill open positions, and finally implemented our second price increase of 2022, which is now in effect. Additionally, we have removed distractions and delayed internal programs to allow our operational teams to remain completely focused on running the business. While the challenges are large, the external environment remains highly dynamic and confident in our ability to work through these issues. We have a talented team who have been working tirelessly to support our customers and our company. I want to personally thank the FlowServe associates for all of their recent and future efforts for their commitment to FlowServe during this volatile time. Let me now return to the details of our first quarter results starting with bookings. MRO activity was solid during the quarter, which supported our delivery of 18.6% year-over-year growth in aftermarket bookings. The $542 million of aftermarket awards we obtained in the first quarter marked the highest quarterly bookings level we have secured since 2014. The growth in aftermarket bookings represents a positive contribution to our full-year financials as it comes with higher margins and shorter cycle times than our original equipment work. Last quarter, we discussed the significant opportunities presented by larger projects that had been placed on hold by our customers due to COVID-related impacts in volatile commodity pricing. We are pleased the poster was awarded several mid-sized projects in the first quarter of this year, each about $30 million in size, plus a larger award of around $50 million. These projects spanned across several of our traditional end markets, including LNG, mid and downstream oil and gas, and nuclear power. The return of this more normalized market environment coupled with our efforts to capture the available opportunities drove our original equipment bookings growth to 11.5%, or $544 million. We also generated bookings traction through our new 3D growth strategy, which we launched at the beginning of the year. This strategy was implemented to take advantage of the changing landscape and to accelerate flow service growth. It is our focused effort to further diversify our in-markets, assist our customers on their decarbonization journey, and capitalize on the digital movement within flow control. We made great progress in the first quarter as our dedicated teams capitalized on each aspect of this strategy. Looking ahead, I'm confident that we can deliver improvement in our traditional end markets as well as accelerate closed service growth through the new 3D strategy. I will speak further to this strategy and some of the progress we've made on it later in my prepared remarks. This quarter, Strong's bookings generated a quarter-end backlog of $2.2 billion, which is the highest level we've had since the third quarter of 2015 and is up 18% year-over-year. Further, we are encouraged by the level of MRO, aftermarket, 3D, and traditional project opportunities that we see on the horizon. Taken together, we believe these factors position PostServe well for revenue growth and improved financial results moving forward. Looking now at our bookings performance by in-market, in our largest served market, oil and gas, first quarter bookings were up over 36% year over year. This improvement was driven by over $120 million of project bookings, as well as several awards from our 3D growth strategy. Power bookings were solid, increasing over 65% compared to prior year, and included some fairly significant nuclear aftermarket and OE project awards, representing bookings in excess of $70 million. Water bookings, a key part of our diversification plans, also provided year-over-year growth of 12%. General industry bookings were down 6%, and finally, following last year's strong performance, chemical bookings were essentially flat year-over-year. From a regional perspective, our first quarter bookings growth was driven primarily from the Middle East and Africa, Europe, and North America, which were up 51%, 45%, and 9%, respectively. Asia Pacific was essentially flat, while Latin American bookings declined 12% versus last year. Turning now to first quarter results and operations. As you will recall, we indicated on our last earnings call that the quarter would be soft, and it was. We faced a very challenging operating environment driven by further supply chain, logistics, and labor availability headwinds and costs, all of which were exasperated by continuing COVID impacts. We experienced a number of significant direct and indirect COVID impacts in the quarter. First, roughly 20% of our associates contracted the virus in the first six weeks of the year. This was a higher infection rate than we had seen in each of the full years of 2020 or 2021. While the Omicron variant severity and duration of illness was much lower than what we experienced in prior years, the effect on our and our suppliers, employees, and facilities, particularly in North America and Europe, rippled through our supply chain and operations. In addition, with the higher number of our associates impacted, we authorized significantly more overtime for those available, adding further costs. We also utilized much more heavy air freight than normal to minimize the impact to our customers. While we took as many extraordinary actions as possible, the combined factors disrupted our ability to complete and ship product at our typical cadence. Omicron subsided in North America through March and April. However, our cases in Europe currently remain high, particularly in Germany, where they reached their highest level in April since the pandemic onset. Also, the current lockdowns in China are impacting our local Chinese operations and a large percentage of our supply chain, which further exasperates the issues with global sea freight as the Shanghai ports remain closed. The conflict in Ukraine began right as we were reporting our fourth quarter results. Since that time, it has continued to add further complexity to our operating environment. Our team has dedicated significant time and effort in addressing the issues arisen by it and the various impacts it has on our business. Amy will cover the financial details, but we made the decision to permanently cease the operations of our Russian subsidiary. We have also stopped accepting new orders for Russia entities and canceled or suspended fulfillment of existing orders in our backlog. In addition to the financial impact of these challenges, there will be an ongoing opportunity cost associated with lost potential new awards, revenue, and profit. But we are firm in our decision to end our activity in Russia. While FlowServe does not operate or have operations in Ukraine, we have provided humanitarian support through our contributions and the actions of our European associates. In addition to these ongoing issues, global logistic lead times and availability deteriorated throughout the quarter, even as the transportation costs were increasing on higher energy prices. The rapid inflation we saw in the first quarter has led us to increase our full-year inflation expectations by nearly 50% above what was originally planned at the end of the year. We now expect the full-year cost of procured items to increase in the high single-digit range year over year, with the electronics, motors, raw materials, and freight being the most impacted. Over recent weeks, I have visited at least a dozen of our sites to review the operations and ensure our teams are best prepared to navigate the current environment. FlowServe is particularly complex as we operate in over 50 countries, have a significant supply chain presence in China and other parts of Asia, and move products and components from site to site within the FlowServe network. As I stated before, we are 100% focused on unlocking the revenue available from our highest backlog level since 2015 and improving our margin performance. We have the work under contract already, and we are determined to mitigate the current conditions, shift the product, and recognize revenue. Before I go into the outlook for the remainder of 2022 and the details of actions we are taking to support revenue growth and to deliver improved margin performance, performance through the remainder of the year. Let me first turn the call over to Amy to address our financial results in detail and our updated guidance.

Thanks, Scott, and good morning, everyone. As Scott just discussed, we are pleased with our success capturing awards in the current strong demand environment and building our highest backlog level since 2015. With that said, we continue to face a number of challenges in the first quarter that impacted our financial performance. Let me walk you through some of the key drivers of our results. Our adjusted EPS of $0.07 in the first quarter was primarily impacted by lower than expected revenue of $821 million and the related underabsorption. The light revenue was due primarily to continued supply chain and logistics headwinds and labor availability disruptions driven by COVID absenteeism and pockets of tight regional labor markets. The Russian-Ukraine situation and the current logjam in Chinese ports further impacted our ability to shift in the quarter. On a reported basis, our loss per share this quarter of $0.12 reflected $0.16 per share impact related to our decision to fully exit from Russia. We also adjusted for below-the-line FX losses of $0.04 and very modest realignment gains. As we described in our 10-K filing and press release, we are taking actions to close our Russian QRC as well as terminate our contractual obligations in the country, resulting in a predominantly non-cash charge of $20 million. Associated with this action, we also removed about $25 million from backlog on existing contracts we have or anticipate we will cancel. As Scott highlighted, our comprehensive flow control portfolio Combined with our strong customer relationships were key in supporting our ability to leverage the end market improvement we're seeing. This combination drove nearly 15% bookings growth year over year or 17.6% on a constant currency basis. SPD's strong bookings growth of over 20% in both original equipment and aftermarket orders was the primary driver. including our capture of several delayed project orders in the oil and gas and nuclear power markets. FCD contributed modest constant currency bookings growth, and as you may recall, FCD typically benefits from project work a quarter or two later than FPD, given its comparatively shorter lead time. Additionally, you'll recall that FCD saw a nice recovery last year in its MRO business, so it represents a more challenging comparative period. Flowster's first quarter revenue declined 4.2% or 2% constant currency impacted by the previously discussed operating headwinds and included low single-digit declines in both SPD and FCD. While we clearly have the work available in backlog, supply chain and logistics issues, as well as the labor constraints, limited our ability to ship and record revenue. Both segments' top-line declines were geographically driven by Asia Pacific and the Middle East, Africa, and Europe, while the Americas contributed high single-digit revenue growth in both FPD and FCD. From a sales mix perspective, OE shipments, as would be expected, were more impacted by the operational headwinds, with both FPD and FCD down mid-single digits. Shorter cycle aftermarket sales were less affected, down a modest 2.8%. Aftermarket accounted for 53% of sales in the first quarter of both years. Turning now to margins. First quarter adjusted gross margins decreased 370 basis points to 26.7%, with FCD and SPD contributing 510 and 290 basis point declines, respectively. The decrease was primarily driven by approximately $26 million of expense related to underabsorption due to lower revenues, as well as the previously discussed material and logistics inflation and labor shortages, as well as the frictional costs we incurred to minimize disruptions to our customers. On a reported basis, first quarter gross margins decreased 380 basis points to 25.5%. This was due to the headwinds discussed earlier, plus the $10 million of charges related to our exit of Russia, which together offset the $9.6 million benefit of decreased realignment activity versus prior year. First quarter adjusted SG&A was largely flat with prior year on continued tight cost management, but increased 130 basis points as a percent of sales to 23.9% due to the lower revenue level. Our improved cost structure has both served well-positioned to leverage the expected near-term growth that we plan to deliver as we work through labor and supply chain headwinds and increase our backlog conversion rates. On a reported basis, first quarter SG&A increased a modest $8 million year-over-year, which included $10 million of Russian-related charges partially offset by the $4 million decline in realignment expenses. First quarter adjusted operating margins of 3.3% decreased 480 basis points year-over-year, with both FPD and FCD down roughly 350 basis points, driven primarily by the decline in adjusted gross profit. First quarter reported operating margins decreased 560 basis points year-over-year to 0.9%. where the previously discussed challenges and Russian-related charges of $20 million were partially offset by the $14 million reduction of realignment spending. And on taxes, our first quarter adjusted tax rate of 22.2% was in line with our full-year guidance of 20 to 22%. Turning to cash and liquidity, as we had forecast on our last earnings call, first quarter operating cash was a use of $27 million primarily due to a build in working capital of $64 million. With the $226 million in sequential backlog growth, we used roughly $50 million for additional inventory and net contract assets and liabilities to prepare for the new work and to increase our safety stock as we work to capitalize on the strong demand environment we are seeing in our served end markets. As a percent of sales, first quarter working capital improved to a modest a modest 20 basis points year-over-year to 29.4%. And while the strong bookings environment and backlog growth has driven increased inventory, I am pleased that our focused inventory management drove sequential and year-over-year decreases in total inventory, including net contract assets and liabilities as a percentage of backlog by 130 and 740 basis points to 32.2%. the lowest level since the second quarter of 2019. In spite of our seasonally lower first quarter cash flows, we maintain a strong liquidity position, including $576 million of cash and $384 million of available credit facility capacity. Finally, other significant uses of cash in the quarter include a discrete foreign tax payment of $30 million, dividends of $26 million, capital expenditures of $14 million, and term loan amortization of approximately $8 million. Turning now to our revised 2022 outlook, we are adjusting our guidance ranges based on a number of factors, including the ongoing supply chain and logistics challenges, hiring challenges in certain key locations, the opportunity costs of lost Russian work, and the continued COVID-related lockdowns in China and the disruptions it's causing in their ports and global supply chain. The headwinds are partially offset by what we expect to remain a stronger demand environment. As a result of these factors, we now expect full-year adjusted EPS in the $1.50 to $1.70 range on full-year revenue growth of 5% to 7%. The revised revenue range is not only impacted by the loss of expected revenue from Russia, but also by the impact of the strengthening US dollar. Clearly, our revised guidance represents a significant improvement compared to our first quarter results. Key assumptions to our outlook include modest progress towards our historical backlog conversion rates, as well as the impact of our latest price increase beginning to benefit us in the third quarter. Supply chain driven delays are also expected to stabilize as we exit the second quarter. and then eases further through the second half of the year. Additionally, we expect shipping conditions to improve and gradually return to normal, including at the ports in China, which are currently impacting our customer and supplier shipments, as well as our internal site-to-site supply chain. The adjusted EPS target ranges exclude $20 million of charges related to our exit of and our expected modest realignment expenses of approximately $10 million, as well as potential future items that may occur during the year, such as below-the-line foreign currency effects and the impact of other discrete items, such as acquisitions, divestitures, special initiatives, tax reform laws, et cetera. Including the Russian exit charges, expected realignment spending and the first quarter's below-the-line FX impacts We now expect our reported EPS in the range of $1.25 to $1.45 per share. Both the reported and adjusted EPS target ranges also assume current foreign currency rates, reasonably stable commodity prices, the continuation of current market conditions, no significant improvement in the Russian-Ukraine conflict, and expectations for our customers to continue to release larger project work in the second and third quarters. We also continue to expect net interest expense in the range of $45 to $50 million and an adjusted tax rate between 20 and 22%. You can find all of our guidance metrics in our press release and earnings deck. In terms of phasing, considering Closer's traditional second half-weighted earnings and cash flows are results in the first quarter, we now expect this pattern to be more pronounced than our initial guidance assumes. as supply chain logistics and labor availability issues are expected to improve throughout the third and fourth quarters. And as our revenue conversion accelerates, absorption levels improve, and frictional costs are reduced, we expect to exit the fourth quarter with operating margins in the low double digits to low teens. As such, due to both the expected ramp in volume and sequentially improving margins, We are forecasting that nearly 80% of our full year earnings range will be generated in the second half of the year. Turning to our expectations for major plan cash usages during the year, we continue to expect to return over $100 million to shareholders through dividends. We also intend to further invest in our business with capital expenditures in the $60 to $70 million range, including the continued build out of enterprise-wide IT systems to further support our operational and productivity improvements. Additionally, we'll continue to invest in our 3D strategy to diversify, decarbonize, and digitize, where we delivered solid Q1 bookings progress related to energy transition and other targeted markets. Let me now return the call to Scott.