Flowserve Corporation 2020 Q3 10-Q Summary
Business context and reporting period
Flowserve manufactures flow-control equipment and provides aftermarket services for oil and gas, chemical, power generation, water management and general industrial markets. Operations are organized into Flowserve Pump Division (FPD) and Flow Control Division (FCD), supported by approximately 16,000 employees and 165 Quick Response Centers in more than 50 countries. This unaudited Form 10-Q covers the three and nine months ended September 30, 2020, filed November 13, 2020.
COVID-19, reduced oil demand, volatile oil prices and lower customer capital spending adversely affected bookings, sales, manufacturing utilization and aftermarket activity. The company reported that all facilities were open and operational as of November 13, 2020.
Financial performance and key metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Sales | $924.3 million | $995.7 million | $2,742.8 million | $2,871.5 million |
| Gross profit | $285.2 million | $332.9 million | $821.4 million | $939.8 million |
| Gross margin | 30.9% | 33.4% | 29.9% | 32.7% |
| Operating income | $87.3 million | $104.6 million | $155.0 million | $282.2 million |
| Operating margin | 9.4% | 10.5% | 5.7% | 9.8% |
| Net earnings attributable to Flowserve | $51.0 million | $59.8 million | $59.4 million | $166.2 million |
| Diluted EPS | $0.39 | $0.45 | $0.45 | $1.26 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $115.6 million | $143.2 million |
Q3 sales declined 7.2%, gross profit declined 14.3%, operating income declined 16.5% and diluted EPS declined 13.3% versus the revised comparable 2019 period. For the first nine months, sales declined 4.5%, operating income declined 45.1% and diluted EPS declined 64.3%.
Q3 SG&A was $200.7 million, or 21.7% of sales, versus $230.4 million, or 23.1%, in the prior-year quarter. Nine-month SG&A increased to $675.5 million, or 24.6% of sales, from $665.6 million, or 23.2%. The nine-month effective tax rate rose to 47.2% from 25.3%, primarily because of a valuation allowance against certain deferred tax assets related to COVID-19 and distressed oil prices.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $921.2 million at September 30, 2020, compared with $671.0 million at December 31, 2019.
- Management reported approximately $1.7 billion of liquidity, consisting of cash plus $745.9 million available under the Senior Credit Facility.
- Operating cash flow was $115.6 million for the first nine months, compared with $143.2 million in 2019. Capital expenditures were $47.9 million; full-year 2020 capital expenditures were expected to be approximately $60 million.
- Total debt and finance lease obligations were $1.710 billion, including $1.684 billion of senior notes, compared with $1.377 billion at December 31, 2019.
- Flowserve issued $500 million of 3.50% senior notes due 2030 and used $191.3 million to partially tender its 2022 Euro Senior Notes. The company recorded a $1.2 million early-extinguishment loss and intended to use remaining proceeds for future debt reduction.
- The amended unsecured Senior Credit Facility provides $800 million of capacity through July 2024. The company had no revolving loans outstanding, $54.1 million of letters of credit and was in compliance with applicable covenants at September 30, 2020.
- The company paid $78.1 million of dividends and repurchased $32.1 million of common stock during the first nine months. The quarterly dividend was $0.20 per share, and remaining repurchase authorization was $113.6 million. The amended credit agreement limits dividends and repurchases during the covenant relief period.
Material changes versus the prior comparable period
- Bookings declined 21.2% in Q3 and 18.9% for the first nine months. September 30 backlog was $1.980 billion, down 8.2% from December 31, 2019.
- FPD Q3 sales declined 1.8%, while FCD sales declined 18.7%. Nine-month FPD operating income declined 22.9%; FCD operating income declined 44.9%.
- Gross margins fell because of lower-margin original equipment mix, lower-margin order revenue, realignment charges and COVID-19-related underutilized capacity. The company expensed $15.0 million of manufacturing costs and related costs during the first nine months because of underutilization.
- The company initiated a 2020 Realignment Program and expected total investment of approximately $75 million. Nine-month realignment and transformation charges totaled $88.3 million, including $72.3 million of realignment charges and $16.0 million of transformation charges. Management estimated approximately $14 million of savings had been achieved by September 30 and expected approximately $100 million of full-year run-rate cost savings after completion.
- Flowserve adopted the current expected credit loss standard on January 1, 2020, recording a $7.3 million after-tax reduction to opening retained earnings. The short-term receivables allowance increased to $76.1 million from $53.4 million at year-end 2019.
- The company revised previously reported 2019 financial information after identifying errors related primarily to unasserted asbestos claims, related insurance receivables and legal fees. The revised Q3 2019 net earnings attributable to Flowserve were $59.8 million, versus $68.4 million as previously reported; revised nine-month 2019 net earnings were $166.2 million, versus $183.9 million previously reported.
Guidance, outlook, commentary and risks
Management expected Q4 2020 bookings to decline approximately 20% year over year and revenue to decline approximately 10%, with slightly less impact on revenue than bookings. Management expected adequate liquidity over the following 12 months but noted that COVID-19, oil and gas market weakness, customer capital-spending reductions, supply-chain disruptions and deferred maintenance spending could continue to pressure results.
Significant contingencies include asbestos litigation. Based on an actuarial study, the company estimated future asbestos liability through 2049 at a range of $80.1 million to $131.7 million and recorded a central estimate of approximately $101.1 million, together with estimated insurance receivables of approximately $87.5 million. Actual claims, settlement costs, insurance recoveries and insurer solvency could differ materially.
Other risks include backlog cancellations or delays, fixed-price project overruns, customer credit and collections—particularly in emerging markets—foreign-exchange volatility, raw-material costs, supplier disruptions, pension obligations, tax valuation allowances, goodwill impairment, litigation, environmental matters, cybersecurity and the ability to realize expected transformation savings. Management stated that disclosure controls were effective as of September 30, 2020 and that no material changes to internal control over financial reporting occurred during the quarter.
Most important facts for investors to verify
- Whether the projected Q4 bookings and revenue declines occurred and how quickly oil and gas and aftermarket demand recovered.
- Progress toward the approximately $100 million run-rate cost-savings target and the remaining approximately $75 million 2020 realignment investment.
- Cash conversion, working-capital requirements, inventory turns, receivables aging and the adequacy of the $76.1 million short-term credit-loss allowance.
- Debt reduction using proceeds from the 2030 notes offering, covenant headroom and the restrictions on dividends and share repurchases.
- Changes in the asbestos liability, insurance receivables, claim trends and outcomes of insurer-related litigation.
- The sustainability of margins after COVID-19 capacity effects, lower-margin order mix and restructuring charges subside.
- The effect of the elevated 47.2% nine-month effective tax rate and future changes in deferred-tax-asset valuation allowances.